Health concerns over takeover trend

27 Mar 2008

Amid market turmoil local IT stars Iona and Horizon are about to be acquired. Is this bad news for the Irish IT sector?

At a time when Iona Technologies, once the darling of the indigenous software sector, is in discussions with an unnamed party about a possible takeover, it’s worth asking some questions about the state of the industry.

Irish tech companies appear to be flavour of the month with international buyers once more. Xiam, a Dublin-based developer of mobile phone software, has just been acquired by the US wireless communications specialist Qualcomm.

In February, Cape Clear was bought by PeopleSoft founder David Duffield for an undisclosed sum. Some weeks prior, miniaturisation firm Tessera bought FotoNation, which produces technology for digital cameras and mobile phones.

The pick of last year’s deals saw Intel buy the games software pioneer Havok for US$110m in cash.

Are these transactions simply signposts on the road to developing Ireland’s tech sector or are they a roadblock to creating an indigenous company of international scale?

“That’s almost become a natural trajectory for Irish software companies: they start up, develop a product, then get to a certain stage and are sold or acquired,” says Shane Dempsey, director of the Irish Software Association (ISA), part of IBEC.

There is a case for saying that acquisitions show Ireland has something to offer larger international players. “At an individual company level, it demonstrates the strength of their ideas, IP and products,” Dempsey says.

“If there’s a concern, there is a question about why our own companies don’t acquire.”

Both the ISA and Enterprise Ireland believe Irish companies could reduce the likelihood of possible takeovers by strengthening the management experience within software firms. The two organisation’s Leadership for Growth scheme is expressly intended to address this shortcoming.

Enterprise Ireland is not unduly worried by the current round of acquisitions. According to its figures, fewer than 70 Irish software companies have been acquired since 1994.

“We would prefer there were almost no takeovers or trade sales, but there’s usually something worthwhile left over,” says Jim Cuddy, manager of the enterprise and finance software department with Enterprise Ireland.

“Very often, the money is re-invested in the economy through those people becoming angel investors or forming new start-ups,” he says.

“We certainly wouldn’t be alarmed at the rate of trade sales, although in the best of all worlds you would like to see the companies growing organically or through acquisition.

“If we could duplicate a Kerry Group or CRH in the software sector that would be good. It’s not going to be either/or, it’s going to be a bit of both. The question is how to encourage start-ups to be more significant players and to avoid being bought up.”

One company which has achieved considerable scale on its own terms is Norkom, which develops software to prevent financial crime. The firm has 330 employees, customers in over 100 countries and expects revenues of €41m this financial year.

“We chose a public listing on AIM and IEX to pursue an independent growth strategy that avails of both organic and acquisitive opportunities to build a global player in the financial crime solutions space,” says a Norkom spokesperson. “We believe we can build shareholder value faster as an independent company.”

Not everyone believes acquisition is necessarily a bad thing. Crannog Software, a Dublin-based developer of network management systems, was bought by Fluke Networks last year.

Neil Wisdom (pictured), business development director with Crannog, believes it has benefited from being part of a bigger entity. “Our sales performance last year also proved the acquisition was successful with strong growth in all markets: EMEA, Asia and the US.”

Crannog rebuffed several acquisition attempts before accepting the right offer and since the merger all, bar one, of the management team has stayed in place without the golden handcuffs of an earn-out clause.

In addition, the parent company has invested in additional software development staff, as well as sanctioning a move to new offices in Dublin.
“I have no doubt that if we hadn’t been acquired, we would have continued to grow through our own self-funding and go-to-market plans,” says Wisdom.

“Who’s to say that we wouldn’t have been acquired for twice the price at a later time or, indeed, if we might have been in a position ourselves to acquire some of our competitors or complementary technologies.

“We weren’t afraid of growth or of continuing to manage and grow our company. It just happened that we received an approach and offer we believed would give us all a decent financial return on our efforts to date and still allow us all to have input and influence in a growing company addressing a growing market.”

John Sterne is the man who literally wrote the book on the Irish software industry. Adventures in Code is his account of the development of the sector since the Sixties.

He argues the ‘cottage industry’ model suits Ireland best. “The whole obsession with growing companies of scale comes from institutional investors. I don’t think it was ever seriously dissected.”

The companies this country produces tend to be niche players rather than sector-dominating behemoths like Germany’s SAP, says Sterne.

“It’s most improbable you’ll ever get a €200m-plus turnover software product company in this country. I think what you’ll get is a whole bunch of €5m-€10m companies.”

Many of these companies will go through the cycle of start-up to product development to eventual sale, but this process need not be the only way the industry operates, Sterne contends.

“In the past, some of the best start-ups were formed by expert users who knew all about niche applications. Or they began as companies that initially supplied technology to Irish customers and matured into exporters. Why are we not seeing newcomers from these backgrounds?”

Other potential obstacles exist but aren’t yet being widely discussed, Sterne warns. These range from technology skills shortages to the reduced influence of software standards groups, which Irish companies have used for influence and networking.

“The big IT firms don’t seem to be putting as much effort into partner programmes for applications software suppliers as they used to do,” Sterne adds. “Are today’s start-ups getting practical assistance from the big six (IBM, Microsoft, Oracle, HP, Nokia, Cisco)?”

There may be interesting times ahead for the software sector. It could well be that takeovers end up being the least of the industry’s concerns.

Dublin firm has every intention of sticking around

Mobile software developer Zamano has managed to plot a course past the tricky €5m revenue ceiling and has yet to be marked as a takeover target.

CEO, John O’Shea, says the company is keen to remain independent and to scale up as much as possible through a combination of strong organic growth and acquisitions.

The markets expect Zamano’s 2007 revenues to be around €24m, doubling to €50m next year.

“It’s likely the growth will come internationally at this point, with Ireland remaining the HQ,” says O’Shea, who confirms Zamano has never been approached by any buyer.

The key, he says, was to enter the UK market at a very early stage. The company was also helped by access to capital from VCs, EI, institutional investors via the stock market and banks.

He is bullish about the Irish software sector as a whole, saying its vibrancy comes from the many smaller companies embracing new business models.

“I think we’re better suited to producing niche players. We just need to find some pretty large niches which enable the development and prospering of some substantial players,” he says.

“Ireland does face many challenges however, which possibly make the failure and selling option the most likely outcome set. Our market is very small, meaning companies have to overcome the export challenge at a very early point in their development to survive,” says O’Shea.

“Scaling beyond this is made more difficult by the lack of access to capital, although the efforts of EI are of great assistance,” he says.

By Gordon Smith