Megabuyte Blog

Credit where credit is due; BT Openreach

It's fashionable these days to knock service provision by large companies, but two recent experiences with BT Openreach have been highly satisfying, and it is perhaps no surprise that the division is now the jewel in BT's crown given both positive market developments and what seems to be a very positive customer attitude from a relatively young organisation.

Without going into too much boring detail, in recent weeks I have had need to call out BT Openreach to repair a line fault in a house in East Sussex and to install a new line in Megabuyte's new office in Scotland. The first required two visits to correct the problem, which arose from a faulty connection at the nearby pole, but booking and then rebooking the engineer was carried out speedily and efficiently online, and given that the fault was genuine, was all done at no cost to me.

The new phone and broadband line in Scotland was ordered via BT Retail, but was carried out by BT Openreach. The engineer turned up at the advertised time and, despite the property having an existing line that was not on BT's records, managed to find the other end 750m away and make a successful connection. What is perhaps more of a surprise is that I am now online with 2Mbps, whilst being 5 miles from the nearest town (Aberfeldy), a broadband speed that many in more urban areas would be pleased to get. We are fortunate that the nearest exchange is just a mile or two away in the nearby hamlet, having been the one exchange to survive from the consolidation of several local ones a few years ago. As the Openreach engineer noted, BT may not have been quite so hasty to close local exchanges had it been able to foresee the broadband revolution.

Maybe my two favourable experiences have been unusual, but what is clear is that BT Openreach is rapidly becoming the jewel in the BT crown from a financial perspective; as we reported on Megabuyte.com, in the last quarter Openreach grew EBITDA 12% on revenues up 4%, a marked contrast to the overall 4% EBITDA growth on 4% revenue declines for the whole of BT. Openreach is benefiting from increased use of local loop unbundling, as well as exploding demand for Ethernet and fibre access.

Openreach's creation was forced upon BT by Ofcom as part of structural separation to create a more level playing field for competing service providers, and to BT's credit it has established an organisation that seems to do what it says on the tin. The engineer who installed the new line may have been a BT Old Timer, but as far as he was concerned, it did not matter whether he was carrying out work for BT Retail or any other service provider. Full marks to BT and to BT Openreach.

The surprising reason why a new generation of quoted software companies is finally emerging

Sitting here in Home House waiting for my next meeting and reading through some of our recent commentary, it occurs to me that, although there has undoubtedly been a flight to private equity ownership in recent years, it also now seems clear that a new generation of publicly quoted software companies is finally emerging. But there is a real irony to the reasons behind this phenomenon.

As I look over recent results, I can see the likes of IDOX, Ffastfill, First Derivatives, Digital Barriers, Advanced Computer Software, Gresham Computing, Brady and others, which have emerged from relatively humble beginnings to have market caps over £50m and, in many cases, well over £100m. Ok, so these guys aren’t yet making up for the loss of Autonomy and Misys, but at least it’s a start.

We have commented in Megabuyte many times over the last couple of years that private equity remains the go-to funding source for mid-market technology companies and, despite the relative success of the companies listed above, I don’t yet see any serious challenge to that statement.  Indeed, as I write, small cap stalwart Kewill is in the process of taking itself private so there’s still plenty of traffic off the market. However, it is very encouraging to see signs of life in the quoted sector and some companies making good use of the capital markets to fund their growth strategies.

The next step that many in the City will be hoping, indeed praying for is the re-opening of the IPO market.  And the successful IPO of Incadea last week was an encouraging sign in that direction as well.

I really enjoyed reading Neil Rimer’s post on the Index Ventures blog recently bemoaning the lack of IPO activity in London, particularly relative to the US market. Although I thoroughly agree with the overall sentiment about the importance of building a complete European tech ecosystem, I’m not sure I agree with all of Neil’s analysis. The idea that there are few tech IPOs in London because companies simply aren’t giving it a go may explain some of the malaise but, to my mind, there is a deeper issue; that VC and PE investors are currently prepared to pay higher prices than institutional fund managers.

If you are a business owner looking to raise capital, why would you accept great dilution AND the uncertainty inherent in an IPO when you can give a way less equity and have greater certainty of a good outcome going the VC or PE route. But why are institutional investors not prepared to pay up? In my view, this is primarily driven by the risk averse nature of fund managers which, in turn, is driven by the fact that they are measured on quarterly relative performance which encourages a herd mentality. It is this mentality that leads to the ‘on-off’ nature of the London IPO market as fund managers swing between ‘fear’ or ‘greed’, but rarely somewhere in between.

Some (including Neil Rimer I suspect) would say that US fund managers are incentivised in exactly the same way and yet they manage to back tech IPOs, so what’s the difference? Well I then go back to the old (and valid) adage that there is insufficient depth of expertise in London to give fund managers confidence, especially in earlier stage companies where risk is inherently higher.

But whatever the reasons for the lack of IPOs in London of late, I am clear that it this dynamic which has favoured companies mentioned above; after all, fund managers have to do something with their cash. And this is especially true when they keep being given more of it by private equity investors buying up their holdings. So, while fund managers are not prepared to invest in IPOs, they are certainly happy to put this extra cash to work in their existing portfolio holdings. So, by extension, we can conclude that this emerging generation of listed software stocks have been beneficiaries of a) the heightened level of P2P activity and b) the lack of IPOs. Oh, the irony.

 

Greece vs Facebook - the technology sector conundrum

The contrasting events on either side of the Atlantic last week could not have more clearly underlined the conundrum that is the technology sector at the moment. On one side of the pond you have the ever-deepening Euro crisis with a potential run on the banks in Greece and Spain while, in Menlo Park, you have Mark Zuckerberg ringing the bell as Facebook goes public as the largest tech IPO of all time. For me, this juxtaposition is emblematic of a dynamic that runs to the very heart of the disruptive nature of technology innovation today which will impact the financial performance, investment dynamics and M&A activity of every part of the tech sector over the next few years.

In the 20 years that I’ve been analysing the technology sector, I have not known a time of such rapid change and innovation; and I include in this the dotcom era which, let’s face it, was more about spin than substance. Today, while there is of course much hype and silliness about social networking, big data etc etc, there is undoubtedly a fundamental technology shift underway.

And I’m not talking about all of the consumer tech stuff which is plain for all to see, I’m talking about enterprise technology. True SaaS applications are slowly transforming the way that businesses interact with data, enterprise social networking in becoming a key component of applications, the merger of content and application is blurring the lines between software and media and the shift of computing power off the desktop and into the data centre is have a dramatic effect, both good and bad, on the performance of many of the companies we track in Megabuyte.

Moreover, the mismatch of growth that we see between the macro economy and the emerging areas of the technology sector is mirrored in the battle between old and new technology vendors. In the dotcom days, while there were certainly major changes in the competitive landscape for consumer tech (viz Google vs Yahoo), the enterprise world carried on almost undisturbed. The big ERP vendor which had grown so rapidly in the 90s continued to dominate and the same can be said for almost all areas of the sector. But I’m not so sure it will be the same this time around. As I look around the tech sector, I see many CEOs with their heads stuck firmly in the sand about what they need to do to maintain growth in their businesses over the next few years. 

In one key way, established businesses have the advantage over their next generation competitors - customers. While next generation start-ups typically have lower development costs than their established peers, they need to spend millions on sales and marketing to build brand and customers. Conversely, established vendors have the opportunity to take these customers with them on their journey to Cloud technologies. After all, the move to the Cloud for most organisations will be an evolution, not a revolution.

But these established vendors must invest in order to capture this growth opportunity. And I’m not talking about simply reclassifying existing capex and R&D as ‘Cloud’, I’m talking about actually having lower profits for a couple of years than they would otherwise have had, in order to build next generation solutions. For me, this is the elephant in the room that the likes of Sage, Logica and others that simply don’t seem to be able to get their head around. As a result, many established vendors that have become used to being market leaders are already legacy players; they just haven’t worked it out yet.

On a slightly different note, we are well aware of this dynamic in our own business; while the world is apparently falling apart around us, we carry on growing and developing. Our customer base continues to grow and we are adding new elements to our service all the time. To support this growth, we have more than doubled our research team over the last six months and we are well advanced on a complete re-launch of megabuyte.com, which will enable us to deliver many of the next generation elements about which we so often write (collaboration, enterprise networking etc) to Megabuyte users.

But that is not to say that we don’t have to take macro-economic conditions into account. We need to be focus our business development strategy on active areas of the market (private equity vs. brokers for example) and our pricing clearly has to reflect the realities of life. But, overall, we try not to pay too much attention to Greece and all of its woes but focus instead on other side of the conundrum; the long term business opportunity afforded to us in helping our customers to understand the financial and corporate implications of the seismic shift currently underway in our sector. 

 

European IT services players are in a cul-de-sac: here’s the evidence

Regular Megabuyte readers will know that I have a bit of a downer on the European IT services companies, especially Logica. For the most part, I think they are caught in a (potentially inescapable) trap between the financial and brand strength of the global US players and the superior pricing model and entrepreneurialism of the Indian guys. Well, Megabuyte analyst Lee Prout has now put together some excellent stats and commentary that really underline just how bad the situation is for the larger European systems integrators.

I have to be honest and say that my opinions to date have been, partially at least, built on a gut feel that the strategic position of the European players is weak; and getting weaker. But when you sit down and do the analysis, the numbers are really quite startling. We’ve analysed aggregated numbers of the main European, Indian and US players looking at regional growth and margins. In the most recent quarter, on average, the European players grew their revenues by an average of just 2.6% while the Americans managed 3.5% (although Accenture’s 11.8% is more representative) and the Indians over 20%.

And it’s not just because the Indians are generating growth in emerging markets; oh no. The European players contest (and the shareholders seem to accept) that it is impossible to grow in Europe at the moment with the Eurozone crisis and the general economic malaise. But the Indian players grew their revenues, on average, by nearly 25% in the most recent quarter.

And it’s not as if the Indians’ price competitiveness is showing through in weak margins; the overall operating margin for the Indian players was over 20% in the most recent quarter, compared to 11.9% for the US companies and just 7.6% for the European players.

And all of this, of course, having an impact on valuations. The average PE ratio of the European players languishes (rightly in my view) at just 8.9x while the Americans sit on a slightly more respectable 10.7x and the Indians on a deserved premium of 15.1x.

But perhaps the thing that grates most with me is the woeful response to this strategic cul-de-sac from the European protagonists. Andy Green’s so called strategic plan for Logica has turned out to be little more than an extended cost cutting exercise (combined with erroneously slapping the Cloud label on many of its services) while the merger of Atos and Siemens IT Solutions was a classic case of ‘leaning drunks’. Of the big players, perhaps only Capgemini looks like escaping from the cul-de-sac, with its attempts to grow by acquisition in emerging economies such as Brazil and by genuinely focussing on developing some service lines around new technologies.

Looking forward, you probably won’t be surprised to hear me say that I am not optimistic. If I were a betting man, I would say that Andy Green won’t make it to Christmas as barely concealed Board wrangling continues. I would like to think that a change at the top could be the start of a new phase for Logica but I fear the strategic malaise may be too well developed to recover. And the same is true, although perhaps to a lesser degree, for most of the other large European IT services players.

But to end on a more positive note, at the other end of the size spectrum, we see lots of innovation and entrepreneurialism from younger UK based IT services players; Amor Group, Rule Financial, Excelian, Salmon, Tessella and FDM Group to name just a few. But that’s a topic for another day.

The full report is only available to Megabuyte subscribers only I’m afraid – download it here.

Note to Megabuyte subscribers: you can expect much more of this type of report from us over the coming months. With an expanded research team (we’ve hired three new guys in the last six months alone), over the summer, we’ll be working hard on extending the Megabuyte Reports series covering peer group dynamics, technology trends and corporate activity across the software, IT services and telecoms landscape. We hope that, once up to critical mass, Megabuyte Reports will become a kind of third leg for the Megabuyte Premium Plus service (alongside News & Commentary and the Database). This element to the service will be formally launched in the autumn. 

 

It's back!

Well, after a three year absense, the Megabuyte blog is back. Those of you who have followed our progress over the last few years will know that the current Megabuyte market intelligence service started life as a free blog in August 2007. Well, nearly five years on, Megabuyte has a team of five analysts covering over 250 public and private companies and our service is read be very many of the sector's top decision makers.

And what a five years it has been. As I dusted down my old TypePad account which has laid dormant for a few years now, I was flicking through some of the old stories (many of which were transfered into the new Megabuyte service in early 2008) and realised just how much has happened over the last few years. So many companies that were high profile players back then are now gone, or have changed completely. Detica, Vanco, Axon and many more.

So why come back with a blog now? Well, I felt that the time was right to augment our formal (subscriber-only) service with a blog that will provide some more personal insights into our thoughts on the technology sector and how our business is developing. There have been many times where, over the last couple of years, I have wanted to talk (indeed rant) about an issue but, increasingly, the pages of Megabuyte are not the right place to do that. So I'll do it here. And you will also get to hear from other members of the Megabuyte team about things that excite, annoy and generally divert them during their working day.

As some readers know, we are in the near the end of a 12 months ground-up redevelopement of the Megabuyte platform and, once that's up and running, we'll integrate this blog into the main site. But for now, it's back to basics with a simple (but hopefully effective) blog.