IT Services: Ripe for Buyouts

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For the past few years, Plano (Tex.)-based EDS, which manages corporate IT systems, has had a rough ride in the stock market (see BusinessWeek.com, 2/8/07, "EDS Puts Its House in Order"). The shares closed on Apr. 19 at $29.21, less than half their market peak in 2000.

Yet despite several quarters of slowing income and revenue, EDS maintains big contracts that produce a steady stream of cash, making it suitable for an LBO. That cash can support debt, a key component in many go-private investments.

More Global Competitors

Why has the IT services sector had such trouble in the stock market? Globalization has been a double-edged sword for many services companies, boosting both risk and opportunity, but battering many of their stock prices.

That, in turn, allows private equity players to acquire them at an attractive price. "Services are among the industrials most amendable to outsourcing," says Phillip Phan, a professor of management at Lally School of Management & Technology at the Rensselaer Polytechnic Institute. Services outfits such as EDS have a much bigger global market now, but that market is full of more competitors. To emerge as a net winner, private equity firms "replace labor with technology, downsizing to maximum efficiency," Phan says.

Private equity firms also wield an important advantage over public owners: They can afford to hire the best management talent. And it's easier to jettison jobs and other costs as a private company, which tend to receive far less public scrutiny.

Services companies say their appeal reflects their growth prospects, too. "We certainly think there are significant growth opportunities in the IT services space, especially in areas such as enterprise security, outsourcing,…software solutions…and servers," Unisys spokesman Jim Kerr says. He estimates the growth range at 8% to 10% for outsourcing and 20% for other markets, including security, open-source, and Microsoft (MSFT)-based software solutions and virtual servers.

Growth prospects also help a buyout firm with its ultimate goal: fixing companies for a return trip to market, where investors are far more likely to appreciate a company's growth prospects than they did before the buyout.

Rosenbush is a senior writer for BusinessWeek.com in New York.