IT channels take M&A road

Two of the three biggest IT distributors in the country—Redington and Tech Pacific—have faced takeover bids in the recent past. And Ingram, the third member of this club, is reportedly trying to acquire Datapro Infoworld. The M&A route is an important trend in the country’s IT distribution business, says Chris Ann Fichardo

How viable is an investment in the IT distribution business?

Taking into consideration the low margins, slow sales cycle and the depressed buying trend, it would be safe to assume that an investment in the distribution business would not fetch very high returns in the present circumstances. Yet, the industry has seen a spurt of activity on the mergers and acquisitions (M&A) front in the last few months.

All the top three national distributors have had their spot under the M&A sun. It began sometime in March this year, when network engineering and IT services company GTL announced its intention to buy out Redington Pte, Singapore and Redington Gulf FZE in the Middle East, for a total consideration of $95 million, in a cash and stock deal. The merger was called off a couple of months later, with GTL offering what the market thought were flimsy reasons for cancelling the proposed marriage. But it did highlight the M&A trend in the channel in a big way.

Then came the news, sometime in June, that the star-performer in the distribution business, Tech Pacific India, would now be owned by CVC Asia, an investment firm, after acquiring a majority stake amounting to A$205 million.

And the buzz in the market is that Ingram Micro wants to buy Datapro Infoworld. According to media reports, the Pune-based Datapro is expected to sell out to Ingram for a total consideration of Rs 4 crore.

Ingram Micro and Datapro Infoworld have both vehemently denied any such move, but from all these instances, it’s clear that some businesses in the distribution industry are up for sale.

Atul Mehta says the channel business is still an attractive proposition and 40 percent growth rates are possible

M&A here to stay

While the growth potential continues to remain undiminished, it is still left unfulfilled, as players are unable to cough up the funds required to develop the market. Shrinking margins have left little funds for development, says Umang Mehta, director of the reseller organisation TAIT.

"When the industry is down, consolidation is going to happen. Local companies are being bought over by foreign distribution companies, as it is only these firms who have the money to invest in these times. However, this consolidation is a good thing for the distribution industry as it will reduce the number of players and increase bottom lines," says Mehta.

The growth potential and vast established base is what is attracting new investment to the channel. "India is seen as a strong growth market, especially as far as demand for IT is concerned. It might not boast of growth rates in the range of 30-35 percent any more, but it still has a robust growth rate of 18 percent, which is better than that offered by most other countries," explains Rajeev Choudhari, associate vice president of distribution firm SES Technologies.

On the market front too, the opportunity is immense. The last few years have seen vendors and channel partners focus their energies in developing B and C class markets, a move that has ensured the spread of IT across the country. Even in verticals, the fight has been restricted to the corporate and SME space, say industry experts. Segments like telecom, where growth potential is just about opening up, and the advent of the low-cost PC, which is expected to open a slice of the market that wasn’t interested in IT products earlier—are bringing more business opportunities the channel way.

While the potential and opportunity are strong attraction points in themselves, the strong channel base in the country is the bait that clinches the deal in most cases. Jangoo Dalal, Cisco’s manager for channel operations in the APAC region, says that in geographically larger countries like India the key differentiators in this business are the availability of proven back-end processes and IT systems. So for those partners who have invested in the business, it’s time to get excellent returns on their investments when the dollars come rolling in.

"Most decisions of buying into a running distribution business are based on size and maturity of operations, as they allow the acquirer a quick entry into the market, which a player would otherwise take years to set up from scratch. Fundamentally, the distribution business is all about putting together an efficient logistics operation combined with a reasonably savvy sales organisation," says Dalal.

Threat or boon?

Acknowledging that the current M&A trend is probably a reflection of the consolidation that has taken place in the channel, experienced players are not too perturbed by it. "This is just a correction happening, bigger companies will always look at consolidating their position. In the long term it’s the intention behind the merger that will make it work or fail," says Choudhari.

Illustrating the example of the Godrej & Boyce and Tech Pacific deal, which happened back in the late nineties, Choudhari says that the merger worked because both parties knew what to expect from it—Godrej knew it did not have the kind of funds needed to grow the business and Tech Pacific got a readymade talent pool to build upon. On the other hand, a merger like that of Ingram Micro and Spectra Innovations has still to stabilise, as the benefits are still not very clear.

In geographically larger countries like India the key differentiators in the distribution business are the availability of proven back-end processes and IT systems, says jangoo dalal

It is estimated that the Indian IT channel does business worth around Rs 16,000 crore every year. The practices and rules that govern trading in this segment have been developed on an ad-hoc basis. It’s only now, as a result of the slowdown, that channel partners are bringing in more systems and procedures into their trading activities.

And while foreign capital will definitely give the channel the much-needed monetary muscle, players are divided on the view that increased foreign investment will bring in more financial discipline into the channel.

"At present, the volumes, the processes and the professional approach are just not there in the Indian IT channel. And here I refer to the locals who do have large multi-country operations, rather than the Ingrams, TechPacs and Redingtons, Today, some of the second level or regional distributors in India are more of funding /credit agencies to resellers, rather than firms providing the strategic and tactical inputs expected of professional distributors," says Cisco’s Dalal.

However, Atul Mehta, managing director of Compuage, says that Indian IT channels have matured and that players do not need to be told how to carry out their business. "Yes, I agree that there are things that we could probably do much better, but the fact is that the channel has put in a number of processes in place and I do not think that we need a foreign company to come and tell us how to do things better," emphasises Mehta.

To merge or not to merge

While M&A activities take place regularly, channel players are more concerned with boosting margins, rather than worrying about where the next takeover bid is going to come from. Market sources say that some national distributors, like Redington for instance, which has faced three takeover bids, have been up for sale for years. It’s not just the national distributors who are looking for acquirers; mid-sized distributors who have managed to survive the slowdown are now looking for buyers too, say industry sources. The financial strain of the last two years is prompting this move.

But some regional distributors like SES Technologies and Compuage feel a sell-out is not an exit option. "The business is still attractive and while margins are shrinking, it is still possible to achieve a 40 percent growth rate," insists Compuage’s Mehta.

Ever since the slowdown began, market watchers warned of this consolidation phase. But it has arrived in the form of a double-edged sword. The foreign-money power of the new companies could well make the going even more tough for partners already burdened with shrinking margins. So for those who have struggled to survive in the business during the last two years, a buy-out might be a welcome relief. At the same time there are believers like Mehta who say that the channel still holds potential for at least the next three to five years. The market will decide who’s right. Watch this space.