Information Technology Consulting Firms: Profit from Consolidation

Sam Subramanian PhD, MBA

Leading information technology consulting firms have received takeover offers. Affiliated Computer Services (ACS) has received a $6.7 billion offer from Xerox (XRX). Perot Systems (PER) has accepted a $3.9 billion offer from Dell (DELL). These transactions unveil a major trend in the technology sector where hardware companies are vying to acquire IT consulting and services firms.

So, why the rush to buy IT consulting and services firms? The reasons are both internal and external.

Internal Factors: The IT hardware business is commoditized and margins in this cyclical business are thin. With IT consulting company shares trading at relatively low valuation metrics, hardware companies are seizing the opportunity to add stable, long-term service revenue streams to their business. Such revenues also offer higher margins and help lessen the dependence on hardware sales.

External Factors: The recession has forced information technology customers to cut their budgets. With limited resources committed, customers now prefer one-stop-shops to solve specific business problems. Rather than procure hardware and software applications from different vendors and use internal staff to bring together disparate technologies, customers prefer vendors who can not only provide the hardware and software but also the brainpower to integrate technologies and maintain networks.

With no dearth of buyers, consolidation in the $806 billion IT services is likely to continue. The list of potential acquirers includes several large, well-capitalized information technology companies including Cisco Systems (CSCO), Dell, Hewlett-Packard (HPQ), and International Business Machines (IBM). Information technology consulting firms are of interest to software giants like Oracle (ORCL) and Microsoft (MSFT) too.

So, which IT consulting firms are next inline to be acquired?

The list of potential takeover targets comes in three categories: large firms, mid-sized firms, and niche players.

Large IT Consulting Firms

Potential targets include names like Computer Sciences (CSC) and Accenture (ACN). Acquirers are likely to value Computer Sciences' access to government contracts. Accenture is more of a long shot given its $19 billion enterprise value and potential for integration challenges.

Mid-sized IT Consulting Firms

Canada's CGI Group (GIB) and Pennsylvania-based Unisys (UIS) are among the firms that fit this description. CGI Group which focuses on IT and business processes is likely to be 'cleaner' acquisition. Unisys with a mélange of services and technology businesses is a troubled company that has unsuccessfully tried to turn itself around for many years.

Niche Players

Salesforce.com (CRM), CommVault (CVLT), and FalconStor Software (FALC) are three players in attractive niche areas that can whet the appetite of acquirers. Recently, customer relationship management specialist Salesforce.com announced a partnership with Cisco. It remains to be seen if this partnership blossoms into something bigger. CommVault and FalconStor provide storage software, a line of business companies like Dell may find attractive.

Profiting from Consolidation in IT Consulting and Services

One way to profit from consolidation in the IT consulting and services space is to invest in potential targets. However, make sure that the specific company is a worthy standalone investment in case the takeover offer does not materialize.

Another alternative is to invest in no-load Fidelity Select IT Services (FBSOX), the only pure-play IT consulting and services mutual fund in town. ETF investors will have to settle for a broad software play like iShares S&P North American Technology-Software (IGV).

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