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“Success usually comes to those who are too busy to be looking for it.”

-Henry David Thoreau

Happy Holidays – martinwolf Annual Letter

To Clients, Partners and Friends of martinwolf | M&A Advisors,

As we begin to close out the firm’s 18th year of operation and start looking forward to 2015, I’d like to take this last opportunity to look back on some of the biggest trends and developments in the IT space for 2014.

First, allow me some space to talk about what this year has meant for us as a firm. We celebrated our 1-year anniversary at our Walnut Creek Headquarters with a new website, closed transactions in eight new geographies across the globe and introduced a new publication: our monthly Executive Perspective piece featuring a leading executive from the IT industry. If you haven’t yet made it out to our office, let me know the next time you’re in the San Francisco Bay Area. We’d be happy to host you.
All that in addition to our regular commentary on important industry developments and major transactions in the space. And it’s been a busy year, both in quality and quantity. The past 12 months have seen escalations of existing trends that I identified at the beginning of the year as well as shifting priorities and developments that have rocked global markets. In the next few pages I’ll share some closing thoughts for 2014 and identify what to keep an eye on heading into 2015.
With that, let’s roll up our sleeves and get started.

Larger than LifeThroughout 2014 there have been headlines about the near unprecedented growth of annual deal activity. Global dealmaking in 2014 as of the close of Q3 reached $2.66 trillion, higher than it has been for five years. And this hasn’t just been limited to the technology industry—the energy sector is highest in terms of total value, while the healthcare sector has seen its strongest period since 1980.

The reason for this? This year is a good year for M&A. And what that means is that there’s a real market. Buyers are finally willing to accept that it’s not 1929, and sellers don’t think that it’s 2001. The result is a healthy amount of activity on every level, with incentives for both buyers and sellers to work together and create value.
The US market and overall economy is also showing important signs of renewed vigor. Despite increased uncertainty abroad (we’ll get to that later), US annual GDP last month grew 5 percent in the third quarter, its fastest rate in more than a decade. On top of that, the latest unemployment numbers showed a growth of 321,000 jobs, the biggest burst in nearly three years. It’s great news, and the fact that it hasn’t been accompanied by increased inflation means we can continue heading forward with more optimism than caution.

Major US market indicators are also reflecting this optimism and close 2014 on a good note overall. Despite a recent dip fueled in large part by increased global uncertainty, the S&P 500 and NASDAQ are both up more than 10 percent from where they started. Pundits have begun to predict a modest 5 percent growth rate for 2015—but as the Wall Street Journal pointed out, that’s the same prediction that was made last year.

 

Uncertainty Abroad

Once you go abroad, however, the optimism begins to falter. I wrote about this in more detail in October, but if the US economy is a roaring fire what we’re seeing elsewhere is more along the lines of embers. It’s very difficult to forecast meaningful growth for international companies because Europe is doing so poorly. And with many large IT players either expanding into or building a presence in Europe, this has significant consequences for the IT industry. I expect to see significant downward pressure on margins and increased price competitiveness, especially for companies that have a strong European presence.
Unfortunately, rather than working to roll back regulations and build a more inviting policy, European policymakers are seemingly bending over backwards to keep conditions hostile. Established companies like Google are facing increased scrutiny on privacy and copyright grounds designed to inhibit competition, and startups like Uber face protectionist and recalcitrant labor laws.

BIC—Not Just A Pen Name
Emerging markets, understandably, are taking this uncertainty the hardest. With the exception of India and its new prime minister Narendra Modi, the BRIC countries are facing severe challenges—particularly as a result of the strong US dollar. China continues to wrestle with slower growth and institutional corruption, though it faces unexpected stimulus from the record low oil prices. But what giveth, taketh away, and while all BRIC countries will be dramatically impacted by the lower costs of oil, in Brazil and Russia that impact is appropriately characterized as disastrous.

Brazil may have pulled off the World Cup this year, but the reelection of President Dilma Rousseff means the country is denied a “Modi Moment” and will struggle to reverse an economic climate with virtually zero foreign direct investment and tepid growth.

And the ruble’s free-fall acts as a de facto sanction on top of all of the existing sanctions—Apple is the latest high-profile company to suspend sales in Russia as the biggest interest rate hike since 1998 fails to stem the currency’s hemorrhaging. Putin needs to do something, and fast, but he’s reaching the bottom of his toolbox. And unless this trend is reversed, BRIC risks becoming an anachronism.

India and China—Still Primarily a Story of Potential
From India and China, we’re not seeing the dramatic effects that we expected on the overall IT industry. There are multiple reasons for this—but more importantly, there are multiple indications that this will be changing in 2015.

The main issue is that Indian and Chinese technology companies first came onto the M&A scene with smaller acquisitions designed more to test the waters or establish beachheads rather than implement long-term strategic shifts.

But starting last year, we anticipated that changing. In my letter at the start of 2014 I called attention to ChinaSoft’s $42 million acquisition of Catapult Systems, a Microsoft- focused consulting company that was notable for being one of the first major cross-border acquisitions by a Chinese buyer. While we haven’t seen any unprecedented acquisitions originating in China in 2014, the region’s increased prominence has been impossible to ignore—especially in emerging hot spots like mobile and e-commerce.

In fact, China’s Alibaba accounted for the biggest IPO in the world, at $25 billion, rocketing the company to unprecedented heights and sending ripples through the broader IT industry (starting with Yahoo, which offloaded 140.3 million shares for more than $9.5 billion in pre-tax cash).
In India, we’re seeing major players recognize that they need to act fast to build capabilities and better compete with established global players. But this is yet to largely translate into activity.

One notable exception: Cognizant’s September acquisition of private healthcare IT services provider TriZetto for $2.7 billion. It’s a landmark deal, spurred by the changing US healthcare landscape. But the key takeaway is that it secures Cognizant’s access to more than half of the insured population in the United States, while positioning the Indian company to strengthen its position in a growing global market.

And while Brazil missed its ‘Modi Moment,’ Modi himself is facing his own Margaret Thatcher Moment. When the coal unions in the UK went on strike in 1984, Thatcher’s uncompromising response broke the power of the unions and cemented her government’s ability to enact policy. Now, Modi’s efforts to make the Indian energy sector more efficient is setting up a similar confrontation—all eyes are on him to ensure the country continues its upward growth trajectory.

(Supply) Chain Lightning
One of the biggest stories of 2014 is the rebounding of the overall PC industry, which saw a confluence of factors contributing to strong overall performance.
Big names like Intel and Cisco end the year up significantly from where they started (44% and 28%, respectively), as they and their peers improve both their products and the ancillary services that they sell along with them. Last year, Michael Dell was in the headlines for orchestrating the largest technology LBO ever. This year, he was writing op-eds in the Wall Street Journal trumpeting the success of his company’s reorganization. And Microsoft, synonymous with the PC industry, found success this year by hiring a new “cloud-first, mobile-first” CEO and taking several important steps like bringing Microsoft Office to iOS (for free, no less) and focusing resources behind cloud and services.

But while Dell’s LBO was the big story of 2013, HP’s split was the big news for 2014. While striking in its boldness, it’s not really a surprise. HP has long been operating as a union of two separate efforts—one featuring low value-add products and one offering high-margin solutions. The two have few synergies, and this change will allow each effort the dedicated focus and support that it needs.

Even VARs and major distributors got in on the action. While some of this newfound life can be credited to Microsoft forcing upgrades by discontinuing support for Windows XP, this year has been all about the broader move to services, often facilitated (and financed) by private equity players. In fact, this year there has been the most consolidation among VARs and professional services providers that we’ve seen in ten years. And this means buyers are expanding beyond traditional markets. CDW, long a stalwart of the sector, signaled it was ready to make its first international acquisition with its minority stake in Kelway.

Let’s Talk 2015
As always, what to look for in 2015 has been heavily influenced by the key trends of today. IT Security was the hot space of 2014, and it will continue to only increase in desirability as it does in prominence. With major attacks like the ones on Sony, Target and the US government (to name only a select few), demand is clearly there. And with big M&A news like the Blackstone/Accuvant deal, Andreesen Horowitz’s investment in Tanium and the Accuvant/FishNet merger all happening this year, supply is rising up to meet that demand.

A word of advice for security companies: start doing some research to see how you can take advantage of these opportunities. And, if you haven’t already, consider hiring a PR agency to get quoted in all of these stories!
But with the positive conditions for M&A showing every sign of continuing, I’d like to go back to a topic that I return to from time to time: acquisitions are tough business, and it’s important to make sure you’re doing everything possible to set yourself up for success. This doesn’t just mean going through the motions and signing off on a press release. It means doing the necessary work to ensure that post-acquisition, the new company is well equipped to work together as a cohesive whole and realize the new value creation.

Let’s look at Synnex, which this year completed its acquisition of IBM’s customer care BPO business. At the time, it was making a $505 million bet that IBM’s low-margin services would for it be a relatively high-margin success story. This year, we found out the bet paid off. The stock is up approximately 50 percent since one week before the acquisition, and the company is benefitting from both its ambitious gambit and successful integration ability.

Despite the broad economic uncertainty, smart acquisition strategy and prescient positioning remains key to success—especially for mid-market IT companies that are not ready to go public or have run into challenges sustaining organic growth in their traditional field. 2014 has paved the way for some of the best conditions in recent history. In 2015, let’s carpe diem!

I wish you all Happy Holidays, a Happy New Year and, as always, Happy Selling! Sincerely,

Marty Wolf

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