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Outsourcing is affecting all sectors of the economy

Grant Murgatroyd at Kleinwort Capital looks at how outsourcing is creating opportunities in the healthcare, technology and manufacturing sectors.

Technology

The technology industry has got out its puncture repair kit and patched up the hole that deflated the bubble. Or so believes Paul Deninger, chairman of Broadview International, the technology specialist investment bank.

Deninger, a veteran of Silicon Valley and global technology markets, was in London at the end of November addressing Kleinwort Capital's Technology Deal Club. "The dot-com revolution was absolutely there, we just savagely overcapitalised and then bled profusely," he says. Leading internet stocks, including Amazon, Yahoo! and eBay, are posting double-digit growth, while the sector's established titans such as Microsoft, Intel and IBM look more like utility stocks. But while Nasdaq has picked up, the recovery is patchy. "People are ebullient, but this is not a robust market by any standards," says Deninger.

M&A activity remains subdued, though Western Europe saw a 26% increase in activity in the third quarter of this year. "There is a return to selective, high value M&A transactions," he says. "Strategic buyers are back and high quality companies will generate very strong exits." The focus is firmly on quality, and the days of valuing companies per engineer are long gone. Traditional valuation methods focused on profits and cash-flow are the order of the day.

So where are the opportunities of the future? No technology pundit gets away without having to predict what will be the Next New Thing. Deninger says: "Even without the next big thing there are enormous opportunities." So where are they? He reckons four areas show particular promise.

First, small will be big, with a push for miniaturisation across the board, driving demand for products that reduce power consumption and heat, systems on chips and generate demand through clever design. Next was the continuation of the IP revolution, with Deninger saying that "everything over IP" will be hot and that, in 20 years, all services from software to music, video and telephony will be delivered over the network. There will be huge leaps in the use of e-business and technology-based services to dramatically improve business process efficiency and aggregate fragmented industries. Security remains a huge issue that will become bigger with as more devices lose their wires.

Media

The implications of The Communications Act 2003 - which revamped the regulatory framework of the industry - are still rippling through the UK media sector. The Act's full impact may not be known for some years.

But for investors at least, one aspect of the Act - the provision of a framework for deregulation to promote competitiveness and investment - is already having a major impact, especially for TV production companies.

"With only four terrestrial channels to sell to, there was the potential for abuse of power," explains Kleinwort Capital managing director Andrew Hartley. "But now the power has moved back towards smaller companies. That's good news for independent production companies and very encouraging for investors," says Hartley.

A number of current influences on the media sector make it an attractive proposition for investors. The rise of multi-channel TV, for example, will require more content-production companies to fill the slots. And the market is maturing, building bigger companies. "Previously, a few creatives would get together to make the programmes they wanted, and the business came second. So companies were not built up beyond a few people. But that's changing," says Hartley.

He cites Hat Trick Productions, makers of comedy programmes such as Have I Got News For You as a case in point. Kleinwort Capital bought a 45 per cent stake in Hat Trick in July 2003, in a deal worth £23 million. "The management team had a track record of attracting creative talent to the business and turning that into successful long-running TV shows," he says.

Hartley says that high stock valuations for media companies in recent years have played into the hands of large trade buyers, which have been able to effectively outbid private equity firms. But the scales are tipping the other way.

"TV Advertising has seen a cyclical recovery in 2004, but it wasn't as large as the industry expected," explains Hartley. "This has had an impact on M&A activity. In the second half of 2004, trade buyers have been more circumspect, integrating previous acquisitions as they wait to see if the recovery will take stronger root. This has enabled private equity acquirers to buy at the prices they're prepared to pay."

Of course, there are still negatives: it is a small sector; purchasing power still largely resides with trade buyers; and the implications of the Communications Act are still to be fully revealed.

But the overall outlook is positive - and Hartley expects Kleinwort Capital to complete at least one deal in the sector in the near future.

Healthcare

Each year for the next five years, the UK Government will increase investment in health services by an average of 7.4% in real terms. It has also set ambitious targets for the NHS.

But the Government cannot meet these requirements alone, and the lines between the public, private and advisory sectors in the healthcare sector are becoming increasingly blurred. This presents exciting growth opportunities for investors.

For example, delivering an increase in permanent capacity is a core function of the government's Diagnosis and Treatment Centre (DTC) programme - which aims to create a network of 'day surgery' centres, where patients can receive the diagnostic and acute elective care they need. The Government expects these centres to lead the way in innovation, productivity and speedy response, and the independent sector will play an important role.

"The Government's plans to grow independent sector diagnosis and treatment centres are being developed with the private sector. These centres will become increasingly prevalent, making it an interesting growth area," says Philip Rattle, director at Kleinwort Capital.

Co-operation is also the key to the growing burden on the domiciliary sector. "Private domiciliary companies geared towards helping public organisations will be a real growth area," says Rattle. "As the population ages, the area becomes more visible."

This new-found sense of co-operation was reflected in the themes discussed at a recent meeting of around 20 senior decision makers in the healthcare sector. Organised by Kleinwort Capital, the closed dinner brought together some unlikely bed-fellows from the private, public and advisory sectors.

Unsurprisingly, the October acquisition of Westminster Healthcare by Barchester for £525 million was one topic on the lips of attendees. The deal created a combined chain of 160 care homes with about 8,000 staff, and follows the £267 million management buy-out of Westminster in mid-2002.

Other topics included the growth of pharmaceuticals sub-contractors, as large pharmas look to focus on core operations. In a similar vein, healthcare staffing and recruitment firms will increasingly be brought in to meet the staffing needs of this growth sector.

Manufacturers of medical devices and orthopaedics equipment also offer opportunities. "The UK has a lot of very specialised, high-quality orthopaedic companies that are still small," explains Rattle. "There's real interest in growing these companies."

Grant Murgatroyd

Grant Murgatroyd is the editor of the Kleinwort Capital newsletter In4mer, as well as editor in chief at Bladonmore Media, which is the publisher of In4mer.

Kleinwort Capital focuses on mid-market private equity investments of between £10 million and £100 million in UK growth companies in the media, technology, healthcare and specialist manufacturing sectors. For more information visit www.kleinwortcapital.com