Economic uncertainty seems to have increased the rate at which software and IT services companies listed on the London Stock Exchange are being acquired, particularly by overseas competitors and private equity groups.

Between March 2007 and March 2008, as many as 15 IT companies announced recommended offers. In April, four more vendors announced they were in takeover discussions, or had already agreed deals.

In most cases, the prices paid were significantly above the level that stock market investors were valuing the company. In fact, premiums of 50 per cent or more are quite common. At Close Brothers, we believe that the rate of IT acquisitions, and subsequent stock market delisting, reflects several factors.

First, many software stocks look cheap relative to the basic fundamentals of the market, with many firms’ price-earnings ratios at­, or near, an all-time low.

Second, business models in the software and IT industry have become more robust. Increasing emphasis is now placed on recurring revenue and cashflow generation, both of which are attractive to buyout groups that want to create new opportunities.

Third, unlike the situation in the technology downturn of 2001, there is a lot of money sitting with recently raised private equity funds and on the balance sheets of larger technology companies, especially in the US. This provides an opportunity for software firms to finance consolidation in what is still a very fragmented industry.

An acquisition is almost always a disruptive event for the acquired company. The principle underlying logic of merger and acquisition (M&A) is that cost savings can be made from eliminating overlapping functions and growth opportunities will be enhanced by creating a broader range of products and services to sell.

Long-term benefits

The immediate and most brutal effect on the target company’s employees is the risk of redundancy, especially in areas such as sales, finance and administration ­ and particularly in senior management. There is also the challenge of integrating cultures, especially in cross-border transactions. But an acquisition can create new career opportunities and better long-term employment security for the people who stay.

Customers of merged IT firms are likely to experience similar short-term disruption, but enhanced longer-term opportunity. Personnel changes may result in new styles of account management and new sales and delivery relationships that take time to bed down.

But IT leaders are also likely to benefit from a broader and stronger range of products and services.

Customers may be concerned that the acquisition of a supplier could threaten the development and support of a core system. Although vendors might have longer-term plans to migrate users of legacy products to new systems, it is rare that an acquiring company will risk losing customers by killing product lines.

From technology leaders’ perspective, the ultimate threat of M&A leads to the dominance of a supplier in one particular market. Such dominance could lead to there being no competition to regulate prices, or to incentivise suppliers to seek innovation and service quality.

Anti-trust legislation plays an important role in preventing a lack of competition and even the most mature customers still enjoy substantial choice in many segments of the IT market.

So far there is little sign that recent takeover activity has reignited investors’ interest in the London-listed IT sector. But while public market sentiment remains weak, overseas predators and private equity firms will benefit ­ and there will be further activity in 2008.

Paul Lewington is a director at Close Brothers Corporate Finance