RELATIONSHIP OF BELL CANADA TO A MERGER OF SDL AND AGT
JANUARY 29, 1971
SDL owns and operates the largest computer in Canada. With its network of high-speed terminal connections, it is the largest non-military high-speed remote job entry networks in Canada and probably one of the largest in North America.
AGT Data Systems is a diversified company in the computer services industry which includes, with its DCF Division, one of the largest computer consulting organizations in Canada.
It is generally accepted in the industry that these two companies would form a natural fit if merged into one corporation. In addition to the obviously complementary nature of their approaches to the computer service field, each company has:
• compatible management teams with similar backgrounds, both having come primarily from IBM
• extensive systems development and computer operations experience in SDL complemented by the equally extensive marketing, application development and consulting experience of AGT.
• combined earnings projections that are extremely attractive
• a proven ability to work together as shown by the marketing agreement already existing between the two companies.
One might ask why these two companies had not yet merged. The direct answer is that each company is young and the management of each had a desire to bring the companies to a position of proven performance. In addition, during this period of intense development, a merger would divert management time from their prime purpose. The management of the companies agreed that should such a merger be desired, it could be brought together at any appropriate time.
A recent analysis of the factors operating in the computer services industry in Canada now indicates that it may be timely to consider such a move. A copy of this paper, in the form of a memorandum to the respective Boards of Directors, was sent to Bell Canada previously.
The result of such a merger would be the largest factor in the Canadian-owned computer service industry, with a staff of over 350 and revenue at an annualized rate of over $10,000,000 a year.
RELATIONSHIP WITH BELL CANADA
The resulting company would be broadly diversified but would have several gaps in being able to offer a fully integrated approach to the industry. As noted in the submission to the common carriers by SDL, dated September 1970, a large portion of the business in the computer services field will involve expenditure for common carrier services, modems and terminals of various kinds. If the new company is to maximize its profits, it will have to supply as many of these services as possible itself.
If this is a logical development for the new corporation, it raises the question of what the attitude of Bell Canada might be toward this company.
1. Bell might take a ‘neutral’ stance:
If it is the intention of Bell Canada not to enter the computer services field, in the near term, Bell could certainly treat the new company as just a new and larger customer.
However, it is likely that there will be continuing pressure for the Bell to take an early position in this field. To begin with, such an investment clearly would provide a better return on capital than the 6.8% earned in 1969. In addition, it would allow the Bell to offer a fuller range of services to its own users, both in the consulting field and by broadening the usefulness of the telephone as a communications device.
If Bell were to enter the computer services industry, this could lead to a sounder expansion of the industry which, in turn, will increase the rate of expansion of Bell’s own business in the communications field.
Finally, it is likely that there will be continuing pressure by the Federal Government to have Bell enter the field through some means or other.
However, should the Bell later decide to enter the computer services field, the competition would clearly be much stronger as a result of the SDL/AGT merger.
Undoubtedly then, Bell could decide to do nothing in the light of the new corporation but as there will be pressures for the Bell to eventually take a stand, there may be advantages in Bell making a move in this field now while it still has all its options open to it. The alternative is that the Federal Government may dictate the moves Bell can make. As a minimum, the environment in which Bell would enter the industry at a later date will certainly be more competitive and more expensive.
2. Bell Canada could enter the field with its own resources:
No one doubts that this could be done. However, experience to date has indicated that any proposals by the Federal Government to push Bell into the field have met with very stiff opposition from the already existing industry. If Bell does enter in direct competition to this industry, it is clear that the industry would have little choice but to enter into data communications competition with the Bell in the lucrative Ontario Quebec market. There is ample precedent for this in the United States with the DATRAN application and others.
While the Bell could certainly locate the capital to enter the field, there might be some reasonable doubt as to whether the Bell could compete effectively as the overhead of the present industry is, in general, less than that of the Bell because the present industry is not required to service areas that are not profitable.
Our experience also indicates that a great deal of experience is required in addition to the capital to make a real success in the computer services industry. The man years of development already invested in the specialized accounting routines necessary for billing customers, the production control systems and the line monitoring software are not easily duplicated. This is illustrated by the fact that in the United States, even the largest companies have been unable to successfully duplicate some of the procedures developed here in Canada. MacDonnell Automation, one of the largest service corporations in the central United States, has repeatedly tried to buy some of these products from SDL.
In addition to the product development necessary in this field, considerable marketing know-how is required. The computer service product is far more complex than the products sold by most companies.
Although Bell has developed a large staff of data processing professionals, this expertise has not been directed towards packaging for resale nor for the demonstrably difficult task of marketing computer-based services.
SDL and AGT have in excess of 50 ex-IBM Canada employees, allowing us the benefits of the proven marketing techniques that have had such demonstrable success over the past decade.
3. Bell Canada could absorb the new company:
If the Bell may enter the field, a more certain way to assure success would be to enter with a successful existing company. In effect, the principle would be to enter the field with, rather than against, the already existing industry.
The first reaction might be that this would cause considerable controversy. However, it is interesting to consider who might object:
• The financial community would clearly be in favour of such a move. Not only would this increase the value of their investment in the major portion of the existing industry but it would add a large measure of profit leverage to the Bell’s own operation, making such a move doubly attractive.
• The Federal Government could hardly object as they have been pushing for such an entry by the Bell for some time. This would meet the Federal Government’s objectives of maximizing the effective use of Canadian computer resources, keeping the industry Canadian and giving the Federal Government a vehicle through which it could implement its national policies as these are defined.
• The users of the combined service will get improved service and, therefore, are unlikely to object. They would not only get the best in co-ordinated experience in the computer/communications field, but would also be dealing with a company that could now offer an integrated product. The research facilities of Northern Electric could be used to develop and build a Canadian terminal, Canadian-designed modems and similar equipment and the already existing marketing and servicing organization combined with the consulting strength of the DCF Division of AGT should provide the best possible product for the user.
• One would expect that other companies in the computer services field would object. However, to be realistic, the major force in the field is still IBM itself and IBM is highly unlikely to register any significant protest. CDC and other manufacturing firms are not extensively involved in the computer services field in any case and would have little reason to object
Also, these firms appear to be getting substantial financial assistance from the Federal Government and would not likely object if the Government indicated it approved of this move by the Bell.
This would leave only a small number of Canadian firms in the field. We would not be so presumptuous as to suggest that the Bell only consider the combined SDL/AGT corporation. Other Canadian companies could be obtained by the Bell if they logically complemented the computer services being offered. With the financial, marketing and technical difficulties being encountered by a number of the companies in the field, it is doubtful if the Bell would want to consider more than two or three other companies and with these effective control of the industry in Canada, outside of IBM, would be obtained.
In addition to the reasons pointed out before as to why it may be advantageous for Bell Canada to make a move into the field through the existing industry, it should also be noted that the price of equity in existing companies is as low as it will likely be. In fact, the potential existing in some of the companies now is one of the factors worrying the Federal Government who have a genuine concern over the possibilities of foreign rather than domestic takeovers.
Needless to say, the internal business that Bell Canada and Northern Electric could provide to the new company would sufficiently enhance the worth of the investment that its value would be ensured.
In particular, the combined SDL/AGT corporation is one with the experience and demonstrated ability that would not easily be duplicated in any other move Bell Canada could make.
In addition to this aspect of the timeliness of an entry into the industry now, SDL/AGT currently have a distinct price/performance advantage over IBM. This is particularly important when viewed in the light of IBM’s current ‘fourth generation machine announcements – the /370 series – which in our evaluation with Northern continued to demonstrate the SDL price/performance superiority even over the new equipment.
It is expected that the ‘life’ of the /370 series will extend beyond five years and, hence, the company can enjoy a substantial advantage that can be exploited over the near and mid term.
While Bell Canada has many options, we believe none will offer better prospects for a successful entry into the computer services field on terms attractive to the Bell than the proposed participation in a joint SDL/AGT corporation.
If such an approach is conceptually attractive to Bell Canada, our companies will make available the necessary financial projections and statements to carry the investigation through its next stage.