The high price of mergers and acquisitions

Mergers and acquisitions appear to have become an unstoppable force in the IT industry in recent years. High-tech companies have wholeheartedly adopted the mantra that big is beautiful.

But despite the activity's undoubted popularity there can be real problems with relying on acquisitions to plug gaps in product offerings.

The Compaq/Digital and Bay/Nortel deals are fine examples of companies with overlapping technology merging to form genuine powerhouses. Both deals saw the buyer gain access to new technologies and markets, and increase shear muscle power.

Alcatel recently bought Packet Engines, a Gigabit Ethernet specialist, for $315m. In this case, the acquisition has given Alcatel access to new technology - and hence new customers.

Take-overs are "low cost gambles" for the bigger player, according to Clive Longbottom, strategy analyst at CSL Consulting. The company can gain access to new technology and incorporate it into its existing product line without spending its own time and money on development.

"Not only does the product benefit, but the deal would also remove the competitor - albeit small - from their playing field," Longbottom said.

And it's not just the purchaser who gains. Matthew Nunney, European MD of Foundry Networks, agreed that technology start-ups are effectively R&D departments for the big players, and added that it's rare to find an IT entrepreneur who won't sell out if the price is right. They rely on coming up with innovative technology and then selling it on. Cash in their pockets - cheap R&D for the buyer.

But despite all this, acquisitions aren't always as beneficial as they might at first appear. Longbottom pointed out one key factor often overlooked: "What the Microsofts of this world need to do is not only acquire the company, but get the entrepreneur behind it to join them."

The entrepreneur can be as valuable as the technology itself. But they rarely want to be a small cog in a large machine. They want to build up small businesses and sell them for a killing.

Bernard Danes, CEO of Packet Engines - a man who has set up and sold several IT companies - pointed out that a lot of start-ups are created to be sold. As a result, those companies on the acquisition trail could end up paying a huge amount of money for "an incomplete company".

Nevertheless, the number of acquisitions taking place is likely to continue growing. To diversify, or gain a foothold in a foreign market, many companies find acquisition is the only option. Non-British revenue for software and services companies in the UK grew by 42 per cent during 1997, largely as a result of foreign acquisitions, according to the Holway Report.

That year was the first time the number of outward acquisitions outnumbered purchases of UK companies by overseas predators. Rising profits and soaring share prices saw UK computing services companies going on a spending spree - with Delphi, Logica, Misys, Sage and Select Appointments particularly active.

But IT companies should beware. Although you may be buying access to new markets and innovative, new technology, you could be losing the most valuable asset of all - the brains behind that innovation.

So technology outfits shouldn't wind down their R&D departments just yet - and any customers of IT companies which boast of their M&A activity should make sure they ask some awkward questions.

A good acquisition is no guarantee of good performance, either in financial - or technological - terms.