ACS: A Private Affair?


An offer to take outsourcing company Affiliated Computer Services private gave its stock a big boost. And there might be more deals to come

The technology sector may have been seen as too risky for private equity firms and their highly leveraged buyouts in the past, but certainly not anymore. The point was underscored on Mar. 20, when Darwin Deason, the founder and chairman of Affiliated Computer Services (ACS), made an offer to take the outsourcing company private.

Deason and private equity giant Cerberus Capital Management teamed up on the $6 billion bid, which is worth $8.2 billion if the company's debt is included. The bid is equivalent to $59.25 a share. "I believe that this offer and our proposed process will maximize value for all of ACS's shareholders, and I am very pleased to be working with Cerberus," Deason said in a written statement.

The stock price of the Dallas-based information technology and business process outsourcing firm soared 16.75% to $59.88 after the offer was announced on Tuesday. The rise suggests that a higher bid could be forthcoming from Deason or a potential rival bidder. Shares of the company approached $65 in early 2006 amid speculation that Bain Capital and other private equity firms would buy ACS, but a deal wasn't concluded. A spokesman for ACS says the Deason proposal is under "close evaluation."

Brush with Scandal

Not too long ago, private equity firms such as Cerberus were reluctant to invest in tech because of the multitude of risks. "Tech was viewed as different than other businesses—too much technology risk, too much risk from unstable cash flows. Now the prevailing view is that tech is like other businesses," says Peter Falvey, managing director and co-founder of Revolution Partners, an investment bank in Boston that focuses on software and tech.

ACS was once among the fastest-growing companies in tech. In 2003, it was No. 72 in BusinessWeek's survey of the 100 fastest-growing information-technology companies. Growth has slowed more recently, however. Revenues grew 23% to $5.3 billion in fiscal 2006, which ended in June. Falvey says growth is expected to slow to 8% in fiscal 2007.

The company has also had a brush with scandal. Last year, it was one of the scores of companies targeted by the government in its probe of stock-option backdating. Several executives were forced to leave, and the company had to restate more than $50 million in earnings. But Deason wasn't faulted in the inquiry (see BusinessWeek.com, 11/27/06, "ACS Shares Higher After Execs Resign").

Why would a private equity investor buy into a once-troubled company with slowing growth? ACS is still a large company, and it's throwing off a lot of cash. The company had an operating income of $617 million in 2006. As founder and Chairman, Deason should "know where all the bodies are buried," says Falvey, making it easier to cut costs and boost cash flow even higher.

Next Up: Microsoft?

ACS has another advantage. Much of its revenue comes in the form of large contracts from government and corporations that pay regular fees. "Any form of maintenance revenue is desirable from the private equity investor's point of view," says Edward Peters, CEO of OpenConnect, a Dallas-based business process analysis firm. OpenConnect is controlled by private equity firm Goff Moore Strategic Partners.

There's another reason private equity firms are beginning to buy so many tech companies. In many cases, it's by default. An entire generation of upstarts was acquired by large strategic companies such as Microsoft (MSFT), SAP (SAP), and Oracle (ORCL), which reported strong earnings on Tuesday (see BusinessWeek.com, 3/21/07, "Oracle Story"). Because those upstarts never had the chance to grow into larger companies, there are fewer strategic buyers in the market, Falvey says.

Practically any tech company may be fair game for a buyout these days. There has even been speculation about Microsoft, with a market cap of $270 billion. Falvey, for one, says such a deal could be done given Microsoft's cash-rich balance sheet and strong cash flow, although he doesn't believe such speculation is serious at this point. The software giant has a reasonable price-to-earnings ratio of 23 and could support a lot of debt.

The idea of a Microsoft buyout may never amount to more than an intellectual war game for bankers. But in the meantime, the growing interest from private equity firms in the tech sector is very much real.

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

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