TMT Sector Comment – April 2017 – IT services


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What the newly launched DXC can tell us about the IT services market today

This month marked the launch of DXC Technology, the $25bn (€23bn) company formed following the merger of Computer Sciences Corporation (CSC) and HP’s Enterprise Service division in a deal announced last year.

Whilst analysts expect that the story will be one of cost synergies for the next few years – the same team cut $1.9bn (€1.7bn) in costs during its three year tenure at CSC – it is the other strategic priorities outlined for the business which speak volumes about the IT services market as a whole.

Firstly, the business is intending to focus on building its digital offering. Currently accounting for around 15% of the business, this comprises services relating to cloud migration, big data and analytics, mobile applications and cyber security. DXC estimates a growth rate in the digital market of 25 to 30% by 2020 and will invest in talent in order to take a larger share of the global pie.

There is no doubt that it’ll be facing some stiff competition, however, as this has also been a key strategy for many of its competitors including Accenture and the major Indian integrators which have been building organically as well as executing strategic acquisitions to add capabilities. Accenture in particular has been a highly active consolidator and on its Q1 2017 earnings call suggested that it may spend up to $1bn (€900m) on digital, cloud and security related businesses in 2017.

The business is also planning “stable” revenue growth of 1% to 4% annually, in line with Gartner’s predictions that worldwide IT spending will grow 1.4% in 2017 and 2.9% in 2018. It is this low rate of growth which has seen so many players in the market turning to M&A to accelerate their topline. However, with DXC viewing M&A as a relatively low priority, analysts are concerned that a lack of transaction activity will both hurt revenue growth and inhibit the business’ ability to accelerate in high value digital areas.

Elsewhere, consolidation activity and private equity investment in the sector have remained at buoyant levels as providers look to accelerate growth and increase scale by consolidating a still fragmented market. In the stand-out deal of the month, Clearwater International advised Irish managed services provider Version 1 on a buy-out deal which sees London-based private equity house Volpi Capital invest €90 million of equity for a significant stake. Version 1 has been one of Ireland’s real technology success stories. The business expects to deliver turnover in excess of €100m this year and has plans to expand into Europe via an aggressive acquisition strategy.

Valuations have also remained relatively strong, although they dipped slightly in the first quarter of 2017 – perhaps in part driven by political uncertainty. Multiples for listed UK-based IT services companies hit their peak in Q1 of 2015 at 13.2x before falling to 9.8x in the first quarter of 2017. Multiples were also impacted by a dip in performance by Redcentric, its share value has plummeted after a financial reporting scandal, and Capita where its IT services division struggles have been well publicised.

As private equity and trade buyers continue to compete for the best European IT services assets, it seems likely valuation multiples in this sector will remain strong. With an ample number of targets available, private equity firms increasingly see the value of IT buy-and-build models, buoyed by numerous examples of successful exits in the sector. Meanwhile, trade buyers will continue to use M&A to outperform a sluggish market and to add near capabilities enabling them to stay ahead of the curve.

Cloudex Comment

Our Cloudex index continues to monitor the performance of publicly listed cloud-model businesses to measure performance against their traditional-model counterparts. One of the strongest consistent performers on the index is Equinix, a US data centre services provider. The business has been successfully positioning itself at the heart of the cloud enterprise ecosystem and has made a number of highly successful acquisitions including Verizon’s data centre sites in 2016, and UK-based data centre provider Telecity back in 2015. Analysts expect the business to continue its strong growth trajectory, as demand rises for data centres driven by big data exchanges.

The Cloudex index grew 2% in March, more than both the FTSE Tech All Share (which stayed flat) and the NASDAQ index (which increased by 1%). There were 82 cloud transactions in March 2017, a slight decrease on the 89 completed in March 2016.

To find out more about our Cloudex index, please visit our website. Watch this space for further information about our 2017 Cloudex Awards programme.