Canadian software companies buying domestic

Canadian companies are increasingly looking within their own national borders when it comes time to make an acquisition, a study from Ernst & Young Corporate Finance Inc. reports.

The study indicates that Canadian software companies are buying competitors and same-sector companies to gain a stronger foothold in the world market. Analysis of reported transactions from 1996 through 1998 indicates that out of 101 technology merger and acquisition transactions, 59 were made by Canadians. In fact, the frequency of Canadian companies acquiring Canadian companies outnumbered U.S. purchases three to one, indicating a change from previous trends that showed U.S. firms as the primary buyers of Canadian companies.

Similar findings were reported by the Canadian Advanced Technology Alliance (CATA) whose statistics also show Canadian software companies using acquisitions as a route to growth in 1998. According to CATA, in each of the last three years, Canadian high tech companies have acquired more foreign firms than foreigners have acquired Canadians.

“A lot of the deals we hear about are the high profile deals and those very often, within the technology sector as well as other sectors, do have or include U.S. companies acquiring Canadian companies,” said Doug Lucky, senior vice-president at Toronto-based Ernst & Young Corporate Finance Inc. “What we don’t hear about is the other 80 per cent of business activity that’s occurring out there that includes a lot of activity among Canadian companies.”

Lucky said some of the key drivers to merger and acquisition activity include accelerating time to market and gaining greater access to both management and development talent. Evidence also shows that technology acquisitions of smaller firms are completed to gain exclusive access to unique technologies, specific products or human or technical capabilities.

Doug McDonald, partner and co-head at Deloitte & Touche Corporate Finance Inc. in Toronto, said mergers and acquisitions are often necessary for smaller companies to remain competitive.

“You have to really attain critical mass in terms of your product capabilities, your customer network, your financial resources. You have to get your business to a certain level to be competitive with other businesses that are getting to that level or are at that level,” he said.

McDonald said customers get a certain level of comfort in “larger, well-capitalized companies who can stand behind their software, stand behind their implementation and all the features that it’s supposed to perform on implementation. And if you’re a small Canadian software company, you have to cross that bridge.”

Currently, it seems a large number of smaller Canadian companies are attempting to do just that.

According to the Ernst & Young study, a large number of these acquisitions involve entrepreneurial businesses. The study found that nearly one quarter of deals had a value of $20 million or less.

This route to growth is often a must for smaller companies, McDonald said, because “if you’re not substantial in relative terms to your competitors then you may lose out in spite of the fact you may have a better technology. You may lose out because people are not prepared to take bets on small software companies.”

The study also indicates that the majority of the transactions involved public companies acquiring private businesses. This accounted for 85 per cent of the deals.

“I think we have to attribute that to the higher values that have recently been ascribed to technology companies…public companies are seeing their shares trading at high multiples and that provides them with an attractive opportunity to acquire other public and private companies,” Lucky explained.

Findings show companies opted for mergers and acquisitions over initial public offerings at a rate of 12 to 1. From the seller’s perspective, Lucky said, mergers and acquisitions are seen as a lucrative long-term growth vehicle and in many cases viewed as a lower risk strategy than an Initial Public Offering (IPO).

“The risk of doing an IPO is that you go to market and 50 per cent of IPOs done over the last three or four years are now trading below their initial public offering price. The risk is that the value of the company is being eroded by the public market,” Lucky said.

Despite the increase in Canadian acquisitions and mergers of Canadian software companies, it is unlikely the industry will ever see only a few companies existing, said David Paterson, CATA’s executive director.

“The history of the software industry is that every time you turn around there’s a shift in the technological foundations of the industry that creates great new opportunities…I don’t think we’re ever going to see the point where there are only three or four companies left in the software industry because every time there’s one of these major technological shifts, it (almost) creates a whole new industry.”

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