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Merrill Analyst: Tech Investors Should Eye Outsourcing Companies In Light of SunGard Deal

Report says premium paid for SunGard shows that IT outsourcing and business-process outsourcing companies are undervalued.
In a report issued Wednesday, Merrill Lynch says the planned $11.3 billion buyout of SunGard Data Systems Inc. by a group of private investors shows that Wall Street is undervaluing IT and business-process-outsourcing services vendors with steady, recurring revenue and strong cash flows.

Silver Lake Partners, the Blackstone Group, Bain Capital, and several other private equity firms have coalesced to purchase SunGard at a 14% premium over its market capitalization at the time the deal was revealed earlier this week. That lofty premium, Merrill Lynch analyst Gregory Smith says, should lead investors to take a second look at IT services and BPO service vendors whose balance sheets resemble SunGard's.

In the report, Smith says Affiliated Computer Services (ACS), Fiserv, and First Data look particularly enticing in light of the SunGard deal. Those stocks, Smith says, "are all trading at very attractive multiples, offer relatively high earnings stability and visibility, generate strong free-cash flow, and should offer good downside protection in any tough environment for technology investing."

Smith says he likes ACS for its strong presence in the fast-growing BPO market, a presence that was bolstered by the company's recent acquisition of Mellon Financial's human-resources-management outsourcing business. He's strong on Fiserv, which provides software and services to the financial industry, in part because he believes the company's outsourcing business will see modest but steady single-digit growth in 2005. And Smith expects First Data "to remain aggressive in buying back its stock at current levels given the company's very strong free-cash flow."

In morning trading Wednesday, the selling price for shares of ACS was $51.94, Fiserv was $38.90, and First Data was $39.56. Merrill Lynch says it does, and seeks to do, business with the companies covered in Smith's report.