By Piers Ford
The frenzy of mergers and acquisitions that many commentators predicted the maturing Middle East IT channel would see by now simply hasn’t happened. Piers Ford investigates why not.
The frenzy of mergers and acquisitions that many commentators predicted the maturing Middle East IT channel would see by now simply hasn’t happened. Piers Ford investigates why not.There’s nothing like a global recession for turning the old adage about safety in numbers on its head. Every man for himself might be a better maxim — and certainly, the rate of merger and acquisition (M&A) activity in the Middle East during 2009 suggests that consolidation is rife across the economic landscape; and not least in the high-tech sector.
According to Mergermarket, by October, the telecoms, media and technology industry had accounted for more than 75% of deals by value, and more than 20% by volume. The combined worth of 17 deals during the first three quarters of the year was US$17.75 billion.
Looking ahead to 2010, however, opinions are heavily divided as to how much impact this trend will have on the channel, where a strong proportion of family-owned businesses combined with high growth rates have always favoured a go-it-alone approach.
But many industry-watchers think that after such a period of prolonged growth, the channel in the Middle East could be ripe for an M&A frenzy of its own, following in the wake of the hardware, software and dotcom sectors, with smaller players in particular entering the spotlight.
Hafeez Khawaja, CEO of HK Consulting, says that in the US and Europe, M&A has definitely brought channel competitors together to pool strengths, and deliver more value to shareholders, customers and vendors.
But to date, this trend has been slow to kick off in the Middle East, with family-led structures, a lack of transparency and cultural reasons also playing their part.“Selling a family-owned business is not seen as a sign of success, unlike acquisition,” says Khawaja. “Over 20% growth in IT has also played its role, and most of the small companies were able to grow and sustain growth without seeing the long-term challenges of continuous growth. Now, with the changing environment and more demands from vendors, they face the necessity to invest in long-term strategy, hire the best people in the market, stick to the best products and vendors who add value to their business. M&A is a must for the channel and it has already started. Delta Business Products’ acquisition by Almasa is an example.”
Samer Karawi, managing partner at Dubai-based G&K Consulting, says there are seven main M&A drivers: cost reduction, the removal of competitors, improving exposure to complementary markets, leveraging the synergy of two merged businesses to meet customer demand, the reduction of tax exposure, improving geographical exposure, and diversification.
Given this considerable impetus, he agrees that the familial element of so many channel players in the Middle East has provided some understandable restraint.
“The majority of large channel business in the Middle East has traditionally been part of a group or a conglomeration of other businesses owned by a person or a family,” he says. “The ICT channel business represents a small fraction of the overall group’s business. The decision makers of the group perceive the ICT channel business to be a complementary business that, while it contributes to the bottom line, is still not ‘core’. This doesn’t mean that the groups are neglecting their ICT channel arms or overlooking business, it simply means that the need for M&A within this particular business is not perceived as priority.”
Also, he explains, the main M&A drivers are often simply not of great enough concern to this type of business, and the likely outcome of a merger may not be tangible enough to justify the investment.
For smaller players, the cost, complexity and risk of M&A is a significant actual and psychological barrier. Many of them, says Karawi, prefer to focus on niche markets where they can enjoy better visibility, higher outcomes and lower risks.
And for channel entrepreneurs, creating a new entity to capture new business in a new geography or sector is still seen as easier, faster and more controllable than buying or merging with an existing channel player.“The cultural differences among the various channels in the region, the structural integration hurdles and the ‘ego factor’ are possible explanations as to why the ICT channel M&A rate in the Middle East is lower than the rest of the world,” he says.
Karawi points out that talk of a uniform recession in the region isn’t necessarily helpful. Some markets have certainly suffered, but others — Qatar, Saudi Arabia, Egypt and Abu Dhabi — have witnessed unprecedented growth. And the Economist Corporate Network Report forecasts growth in the Middle East region to achieve a comparatively (with the rest of the world) favourable 4.4% in 2010.
“In essence, the relative growth of the region hasn’t slowed down as dramatically as we thought,” he says. “In fact, a geographic shift in business has happened and driven the channel business shift to focus on the highest growing countries and best business opportunities.”
What, then, of the vendor’s role in encouraging — or at least influencing — consolidation? Certainly, they will make their influence felt. But self-interest and the constant drive to maximise customer bases mean that they will always be treading a fine line.
“The interest of a vendor in having its channel consolidated, besides reducing its channel management cost, is to secure a fund-rich channel with large geographical coverage and less competition among the channel itself,” comments Karawi.
“Conversely, this represents a threat to the vendor, as it will have to deal with major channel entities that can dictate the market conditions and the sales rules, which will erode the vendor’s margin and remove the control of its business from its hands. From that, vendors should encourage M&As in their channel carefully, as well as select the companies where M&A will achieve a business value to the customer, the channel and the vendor.”
HK Consulting’s Khawaja says vendors are not driving M&A in the Middle Eastern channel in the same way that they have in the US and Europe, partly because their strategic decision makers are usually based so far away from the region. “Some have local sales teams to close deals, but the time has come for them to use local talent to drive these [M&A] initiatives,” he says.“Why should we encourage channel consolidation?” counters Mohamed Itani, regional operations manager at HP Middle East. “We are driving specialisation. For example, a channel partner who specialises in consumer goods has a different structure than the one who goes after commercial customers. HP has a wide range of products and go-to-market routes, and we encourage focus and specialisation. In addition, we cannot look at the Middle East as a consolidated market. It is a cluster of countries, each with its own local channel structure and network within that country,” he points out.
Itani is unequivocal. Vendors should not interfere in channel consolidation, he says. Others say that they can have an impact, albeit indirectly, through management of credit lines.
Ali Baghdadi, CEO and president at IT distribution house Aptec, which is something of an M&A veteran in the region since its acquisition of Tech Data Middle East in 2007, suggests that better-than-expected distributor profits in the recession have kept vendor influence at bay to date.
“I believe the key driver to consolidation is going to be vendor credit,” he says. “Most suppliers have become stricter with credit, and credit insurance companies have reduced their cover on most countries in the Middle East. Financially weaker companies will lose credit lines, while strong ones will at least stay. While I would have expected some vendors to increase the number of their partners or distributors, most have started to rationalise the number. The vendor is mostly interested in supporting the profitable companies and making them more profitable at this stage.”
Samer Karawi says vendors’ portfolio enrichments and consolidation like Sun’s merger with Oracle, or HP’s acquisition of 3Com, will in turn drive some level of consolidation in the channel — although previous history suggests that they tend to let the channel make its own adjustments rather than actively driving M&A.
“I would expect this to happen again and would advise the channel not to wait for the vendor’s intervention,” he says. “Alternatively, the channel needs to become proactive, read the market and trends, and anticipate the next move instead of waiting for the vendor’s help or the market to decide on their behalf.”
Karawi says margin pressure will also be a factor in channel consolidation. Ever more exacting customers and fierce competition, the arrival of hypermarkets and the fixing of end-user prices all pose considerable challenges for smaller players in particular.“Driven by cost reduction, margin erosion and competition, I expect many small players in the channel business to enter into necessary, if not vital, M&As,” he says.
“The large traditional retail channel will slowly disengage or reduce its exposure to the retail market by diversifying its portfolio and expanding in new geographies.”
Hafeez Khawaja agrees that 2010 will see at least the beginning of channel consolidation. “Those companies who want to enhance their product portfolio or channel portfolio will look for those who have an incremental customer base in one area — retail, reseller or enterprise, for example,” he predicts.
“I think the channel should not look at it negatively, if someone is interested in their business. It is a positive sign that they have managed well, and together in a bigger structure they can meet the new challenges of the 21st century. A good opportunity not properly evaluated and cached is lost for ever!”
Aptec’s Baghadi thinks that several distributors could put themselves on the market in the coming year, as cash shortages and the declining market sector take their toll. He also says the channel’s perceived lack of transparency still needs to be addressed.
“I see this as a major issue, as it substantially increases the cost of due diligence,” he says. “Moreover, it generally implies that international accounting standards and governance are not in the culture of many companies. This reduces the confidence of larger and more established entities.”
For those channel businesses who are prepared to take the M&A plunge, Baghdadi has some strong advice: make sure there is a strategic fit between both companies, and plan and tackle the merger of both your company cultures from the very start. “And protect your key staff,” he counsels. “They are your most important asset and they will leave if they are fearful of what the future may bring.”