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Wall Street's grip on IT providers a 'new reality'

The effect of activist investors and leveraged buyouts on IT providers is something that can be advantageous in IT buying decisions.

You hear it more and more these days -- IT providers say it is business as usual while the company is under pressure from activist investors or faces a buyout. Are they telling the truth?

Not according to Gary Spivak, a research director at Gartner.  

"The concept that it is business as usual -- I'm not buying it; it almost never is," Spivak told attendees this month at the Gartner Data Center, Infrastructure & Operations Management Conference in Las Vegas.

A leveraged buyout or activist investor activity within an IT provider is more than a "Wall Street event" and IT professionals should pay close attention and incorporate corporate unrest into their IT vendor evaluations.

IT should keep an eye on financial updates from their hardware and software vendors, especially those in transition, and use disruption to their advantage, he said.

"Utilize the disruption to evaluate and negotiate better terms," Spivak said.

It is common that customers are told that everything is OK and nothing will change.

"Challenge them on that," Spivak said. "Understand you have the knowledge that things are different and convey that to them."

Front and center is Dell's planned $67 billion purchase of EMC, which is expected to be completed sometime in mid-2016.

EMC and Citrix are the latest in what Spivak describes as enormous number of IT vendors targeted by activist investors. The activity has increased since 2009 and for good reason, since the activist investors typically get returns that exceed the Dow Jones Industrial Average, he said.

Merger activism is increasingly a strategy for hedge funds. One fifth of firms targeted by activists get a takeover bid within two years, he said. By 2020, eight of the top 12 IT operations vendors will be forced to respond to activist investors to sell some or all of its business, Spivak predicts, up from just two today (EMC and Citrix).

At one point, Spivak said he would have thought EMC was so large that it was out of the reach of activist investors and a leveraged buyout. If EMC is a target, any company could be next.

"It raises the question -- what's too big?" Spivak said. "I'm not sure I have the answer to that."

Chris Schuttger, a senior systems architect at Northrop Grumman Corp. in Austin, Texas, works in a Dell and EMC shop.

"We know we are going to be impacted by the Dell-EMC acquisition," he said. "We're not going to change from Dell anytime soon but we could change from EMC -- that is more likely."

Jean-Francois Charlebois, principal director of infrastructure at PSP Investments in Montreal, Canada, said his organization is a significant VMware and EMC customer, and the Dell-EMC deal may impact their IT buying decisions.

For example, his company has been considering VCE products, but he's not sure what will come of EMC and Cisco's VCE partnership, he said.

The influence of activist investors and leveraged buyouts will likely continue to be a consideration in the IT buying process, he said.

"It is a new reality," Charlebois said. "I did not see this as much 10 years ago."

Charlebois counts Microsoft, Hewlett Packard Enterprise and VMware among the vendors he often negotiates with. It is important to know the position of each company and how he could use it to his advantage, he said.

"I want to know the impact on me and what I can do better to negotiate, whether it is pricing or timing," he said.

Buyers with knowledge about their IT provider's financials are in a better position, Spivak said.

"Armed with this knowledge, use it to your advantage," he said. "Vendors are banking on you to not understand these things because it is not in [your] interest."

Many IT professionals focus on the financial factors of a company that least affects them. Half of IT professionals that answered a survey from Gartner said that they would reevaluate their relationship with a vendor when a vendor sells off a business unit to another vendor or the vendor is acquired by another vendor.

But very few said they would reevaluate their relationship with a vendor when activist investors demand changes in the company or when the vendor is acquired by a private equity firm through a leveraged buyout.

Infrastructure and operations professionals have their priorities inverted and are "misfocused" on the most important actions, Spivak said.

Questions about a vendor often start to emerge after activist investor action or a leveraged buyout. That's when IT professionals will start to see areas where the goals of activist investors don't align with data center professionals.

The most disruptive activity is when the activist comes out and says 'this company needs new management, it needs to change.'
Gary Spivakresearch director, Gartner

Typically, data center professionals want IT providers to develop reliable products that are enhanced over time; they want to be able to get the support they need and they want cost-effective pricing all from a healthy vendor that will be around to support long-term goals.

Elliott Management Corp., which owns 8.5% of Citrix, made recommendations based on Wall Street, not IT customers.

"They were not focused on improving the things that matter to [infrastructure and operations] leaders," Spivak said.

Instead, short term investors, including activist investors, will typically invest for a quick product announcement or quarterly earnings. While that may not hurt, it is likely not helpful to IT professionals, Spivak said.

"The most disruptive activity is when the activist comes out and says 'this company needs new management, it needs to change,'" Spivak said, with a letter demanding the changes.

That's something a technology company's management team cannot ignore.

"Think of what is going on in the mind of the CEO as this is all going on in public; he is accused of having an ugly baby and being a bad parent," Spivak said, something that invariable creates uncertainty within the customer base, prompts employee questions and creates many distractions.

After the activist investor activity ends, it is often easier to transform the company outside the public eye, Spivak said, although the downside is that as much as 60% of the purchase price has been financed.

In the EMC buy, for example, that will mean $45-50 billion in debt for Dell.

"That debt used to buy the very company becomes an obligation, a liability of the company," Spivak said. "That is, initially, a very huge burden they didn't have before."

Companies are often targeted by activist investors because they are profitable and have strong cash flow, but, after the purchase, the company becomes less profitable because of interest expense, which can lead to cost-cutting. Those cuts could come down on research and development as well as products that are not seen as material to the growth of the company.

Schuttger, of Northrop Grumman, said his job involves coming up with the technical recommendations and suggesting vendors to use to solve specific problems.

"I always want to know more information to make decisions," he said, which is what prompted him to take Spivak's advice.

At the top of his list of selection criteria for IT providers are the features, functions and cost of a product and how each of those criteria will help him meet his service-level agreements (SLAs) and budget. But the vendor's financial stability should also be a factor.

"This will come in mid-range to lower-range as part of the evaluation of a vendor," he said.

He acknowledged that future features and functions of products may take a backseat for a company that has recently faced corporate unrest, but he most often looks at what is in the portfolio today.

"I need to meet the SLAs this month, I can't wait," he said.

Spivak suggests that IT buyers not rush to kick out a data center vendor that faces investor activism or a leveraged buyout. He does recommend avoiding long-term commitments with the company and then taking time to figure out if the company's products in your data center are strategic to the vendor or are simply ancillary.

"If it is ancillary, your actions need to be more drastic," he said, noting those products could be spun-off or see underinvestment.

No matter what, IT buyers should incorporate the financial status of IT providers as part of their vendor analysis.

"If we do that, we will open the eyes of the vendors, activists and private equity firms," he said.

Robert Gates covers data centers, data center strategies, server technologies, converged and hyper-converged infrastructure and open source operating systems for SearchDataCenter. Follow him on Twitter @RBGatesTT or email him at [email protected].

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