DEALTALK-IT services in sweet spot as M&A gathers steam

* Improving spending, economy increase appeal of IT services

* Hardware, software firms looking for stability eye services (For related factbox click on [ID:nBNG257199]; for more Reuters DEALTALKS, click [DEALTALK/])

By S. John Tilak

BANGALORE, Oct 28 (Reuters) - The U.S. information technology services sector is likely to be a focus of merger and acquisition activity as its companies are among the most attractive in the technology space.

A rebound in tech spending has increased the appeal of IT services companies and put them in the crosshairs as deal momentum picks up in the industry.

The ongoing recovery in the economy and credit markets has made tech companies look for ways to come out on top, and they have shown a willingness to pay hefty premiums in a sector that has historically commanded high prices.

IT services firms have a recurring revenue stream, high margins, a strong growth outlook and impressive returns on investment, making tempting targets for buyers. They offer consulting, software services, business process outsourcing, systems integration and interactive marketing.

Cash-rich technology giants plan to strengthen their portfolios, and smaller firms want to stay in the game through acquisitions as their larger rivals become even more formidable.

Attractive acquisition candidates include Sapient (SAPE.O), Computer Sciences (CSC.N), WNS (WNS.N), Amdocs (DOX.N), Cognizant Technology (CTSH.O) and ExlService (EXLS.O), analysts said.

Consolidation is under way. In September, Xerox Corp (XRX.N) said it would buy Affiliated Computer Services Inc (ACS.N) in a deal valued at about $5.5 billion, and Dell Inc (DELL.O) said it planned to buy Perot Systems Corp PER.N for about $3.9 billion.

"The pattern here is that you have commoditizing tech product companies looking for a strategy that's better than doing nothing," Sanford C. Bernstein analyst Rod Bourgeois said.

"They're looking at the IT services industry to juice up their struggling tech product business."

Possible acquirers could be tech giants such as IBM (IBM.N), Hewlett-Packard (HPQ.N) or Cisco (CSCO.O), European players like BT (BT.L) or Deutsche Telekom (DTEGn.DE) and Asian companies like Hitachi (6501.T), Fujitsu (6702.T) or NEC (6701.T), analysts said.

"There's definitely going to be some strategic acquisitions -- there's no doubt about that," Goldman Sachs analyst Julio Quinteros said. "It's just, how much are you willing to pay? And would you rather wait for the market to come back a little bit?" The recurring revenue stream that IT services firms have gives them more visibility and stability.

"What's driving a lot of this is the evolution of hardware companies looking for more stability and recurring revenues that are typically associated with services models and by the same token software companies potentially looking for the same thing," Quinteros said.

Hardware and software companies want to diversify their portfolios by adding services, to help them survive and even prosper through tough times.