ACS, CSC, Outsourcing, Equity, Buyout

ACS & CSC shares drop as buyout talks fizzle

23 Jan 2006 | (News)

Technology outsourcing company Affiliated Computer Services, Inc. said that buyout discussions with private equity firms have ended, sending its shares down more than 7 percent.

Reports of private equity bidders surfaced in late December, with a possible buyout price said to be between $62 and $65 per share, or around $8 billion. That helped push ACS shares up more than 10 percent in recent weeks.

ACS on Tuesday said it has been considering alternatives including a sale to private equity firms as well as a possible dual class recapitalization proposal described in the company's proxy statement of Sept. 30, 2005.

"The company did not reach agreement on either of these alternatives and they are no longer being considered," ACS said in a statement.

ACS shares fell $4.42, or 7.3 percent, to $55.90.

The failure to reach an agreement marks the second time in recent months that a private equity bid for a technology outsourcing company has faltered.

Computer Sciences Corp. shares dropped more than 11 percent on Nov. 21 following reports that a group of private equity buyers and a corporate partner abandoned talks to acquire the computer services company. CSC shares are back up on reports on renewed takeover talks.

Private equity firms, which buy companies using debt and sell them later for a premium, are attracted to the sector because it generates steady cash flow.

The IT-outsourcing business is characterized by contracts of at least five years that generate recurring revenue streams. That appeals to private-equity firms, which often finance acquisitions by loading their targets up with debt that can be paid off with future earnings. The more predictable the future income, the easier and cheaper it is to borrow more.

However, some experts said this week that regular contract renegotiations, competition and the cash-dependent nature of the business mean computer-outsourcing isn't a good fit for leveraged buyouts.

"The failure of this [ACS] deal to pass, as well as the apparent breakdown of talks between private-equity firms and CSC should signal that capital-intensive outsourcing firms may not be the right targets for buyout firms," said Abhishek Gami, an analyst at Banc of America Securities.

After three or four years, IT-outsourcing contracts are usually renegotiated, often in favor of the customer, added Gami.

That causes problems because outsourcing companies often have to invest a lot of money at the start of a contract to get projects up and running, he elaborated. For instance, when operating a company's data center, outsourcing firms buy equipment and other assets from the customer and often have to make other startup investments.

That means contracts can be unprofitable during the first couple of years, leaving outsourcing companies to make the profit back in the final years of the project, Gami said.

A renegotiation late in a contract's life can disrupt the outsourcing company's plan to recoup its initial investment, the analyst noted.

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