Mergers are in the Air

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Though many tech vendors are suffering as the widening U.S. financial crisis slows down consumer and business spending, IT mergers and acquisitions including bellwethers such as Microsoft, Google, Yahoo, Electronic Arts and AOL continue to reshape the technology landscape and provide opportunities for investors.

AOL's announcement on Thursday that it will buy social-networking site Bebo for US$850 million is just the latest example that IT companies are not letting a depressed market get in the way of strategic purchases.

Economic Worries

The macroeconomic news and fresh data on IT returns this week are, as usual, not heartening. A survey released Thursday by research company ChangeWave shows that the U.S. economy is already in recession. The Feb. 27-March 5 survey of 3,345 professionals in U.S. businesses found, among other things, that 30 percent of those polled forecast first-quarter sales to come in below plan. This is 5 points worse than the company's previous poll.

"You have to go all the way back to 2002 to find a downturn of this magnitude in a ChangeWave corporate survey," said Tobin Smith, ChangeWave founder, in an e-mail note accompanying the report. "There's no doubt anymore the recession is now here," he said.

The general downturn is having a marked effect on many IT vendors. For example, in a software research note, Citi Investment Research on Thursday reported a marked decline. "After five years of positive full year returns, the software sector is posting negative returns so far in 2008," wrote Brent Thill and John Reilly Walsh.

Median software company earnings are down this year by 14 percent, compared to the tech-heavy Nasdaq Composite Index's decline of 15 percent. Since October, software sector returns are down 20 percent, matching exactly the Nasdaq's fall since then.

What's an IT investor to do?

In Crisis is Opportunity

"In this uncertain environment, potential M&A targets may provide the best opportunities for appreciation," wrote the Citi research team.

Overall tech M&A activity will likely decline this year as turmoil in financial markets dampens tech buyouts from private equity firms, which had a record for acquisitions in 2007. However, this will not necessarily deter cash-rich tech companies themselves from acquisitions. Acquisitions are a quick way to bring in new technology in fast-moving sectors like the Internet, or expand market reach in mature sectors such as enterprise software.

The most obvious example of these trends is Microsoft's bid for Yahoo, announced Feb. 1. The offer was originally valued at $44.6 billion. Since Microsoft stock is part of the deal, the total value of the deal has dropped as the software giant's share price declined after the offer was announced. Many industry insiders believe that Microsoft will find it hard to integrate the companies, which have overlapping product lines and services. However, the offer has boosted Yahoo's share price, from the $19 level at the end of January to the $28 level now. One caveat, if Yahoo successfully resists the deal: Look for its share price to fall again.

On Thursday, shares of game developer Take-Two Interactive jumped $0.73 to close at $25.64, after Electronic Arts offered shareholders a tender offer of $26 per share. EA made the offer after Take-Two's board continued to resist its entreaties. EA has been pursuing Take-Two since Feb.19, when its offer was a 64 percent premium on Take-Two's Feb.15 share price of $15.83.

Share prices of acquiring companies don't often go up on acquisition news because a big buyout can dilute earnings for a while. EA's share price has fluctuated with the market in the past few weeks, closing at $48.95 on Feb. 21, when the offer was made public, and $47.26 on Thursday.

Google Bounces Back

Google's share price has plummeted along with the market in recent weeks, but rose Tuesday by $26.22, to $439.84, after European regulators approved its purchase of DoubleClick. With DoubleClick, Google should be able to deliver more relevant advertising.

If you were not an investor in Yahoo or Take-Two (DoubleClick and Bebo were private companies), take heart, there are plenty of takeover targets out there.

Citigroup says to take a look at, among others, data-integration software vendor Informatica, trading at $17.79; middleware vendor Tibco, trading at $7.55; and data-center software provider Bladelogic, trading at $23.71. In any case, these companies are cheaper than Google, trading at $443.01 on Thursday.

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