The business of providing language services like translation and localization is critical to global commerce, branding, and other communication. Globalization has made interpretation, dubbing for TV and film; and translation of documents, software, product information; and websites commonplace items on any knowledge worker’s task list.(1) But as a US $10 billion industry, (2) it remains highly fragmented and a bit obscure even after several waves of consolidation over the last decade.

Common Sense Advisory believes that the language industry is poised for more consolidation driven by the quest for more market effi ciency, better technology, rationalized offerings, and global scale. At the same time, we see it continuing to be a very fragmented industry. We see a fundamental paradox here - the industry must consolidate, but won’t change very much. If you’re a buyer of language services, how this industry drama plays out should prove very interesting in your planning. How it evolves will have a profound impact on how you buy the services that keep your company able to operate internationally.

MERGERS & ACQUISITIONS AMONG LANGUAGE SERVICE PROVIDERS

Mergers and acquisitions (M&A) in the language industry have been on everyone’s mind since Lionbridge acquired its much bigger rival, Bowne Global Solutions, in June 2005. That same month SDL upset the technology side of the market by swallowing its smaller but dominant competitor, Trados. Since then, middle-market language service providers such as TransPerfect/Translations.com and Welocalize have snapped up a raft of smaller companies, while other players like euroscript, from Luxembourg, absorbed firms closer to their own size.

For the last two years, "selling for a good price" has also been a hot topic among owner/operators and at conferences. Big investment bankers like Goldman-Sachs and equity research firms such as Clear Capital evaluate the few publicly traded firms as they do for the leading companies in any industry. Meanwhile Common Sense Advisory sees that the market will continue very similar to certifi ed public accounting, in which a few mega-sized companies dominate the headlines and handle work for publicly traded companies, while thousands of smaller firms deal with the masses of small and medium businesses that also require such services. However, market realities will keep the industry in its current pregnant state as buyers wait for sellers to meet their terms and conditions - and sellers hold out for enough to buy that villa in Tuscany.

Today, a few notable but not impressively large firms lead the charge. The question that everyone asks is who will consolidate the industry - today’s leaders, smaller but more aggressive agencies, services firms from outside the business expanding their portfolios, or newcomers backed by venture capital or private equity?

Of course, none of this consolidation will happen in a vacuum. The demand for language services increases year over year, driven by consumer need, corporate desire to provide more content in more languages, and government regulations. At Common Sense Advisory, we characterize these drivers as "market-driven localization, "all a function of buyer needs.(3)

IT HAPPENED BEFORE, IT WILL HAPPEN AGAIN

Mergers and acquisitions have been a fact of life in the language industry for the last dozen years. As long-time observers, we note several periods of increased consolidation in the translation and localization market.

• The language industry as we know it began in the 1980s. The beginning of the translation and localization specialty started with small agencies like GECAP, Harvard Translations, ICI, I LE, INK, ITP, Logos, M2 , McElroy, Polyglot, Randall Woolcott Services, S&D, and Tek in the 1980’s and early 1990’s. Through the 1990’s, these companies ebbed and fl owed as firms like Mendez, Lernout & Hauspie, LMI, Berlitz, Bowne, Lionbridge, and SDL snared companies in their bid to grow to a size and visibility that would attract customers. Their goals were to assemble a global footprint and reach $50 to $100 million in revenues.
• The pre-2001 web inspired dreams of localization fortunes. In the late 1990’s the web widened the world of translation and localization, creating new demand for language services as everybody deployed their global websites. However, the party came to an end in 2001 when the internet-infl ated bubble burst, shutting down many companies’ ambitious global website projects and threatening the existence of many language service providers. While several large transactions occurred, these were themselves triggered by implosion from the downturn - Lernout & Hauspie’s fabled meltdown in December 2000, the dispersal of L&H assets such as Mendez and Dragon over the next couple of years, and Berlitz’s acquisition by Bowne Global in 2002 stand out as the wave broke. This otherwise fallow period lasted until 2004 when activity resumed, both in startup activity and in consolidation by the bigger players in the marketplace. During this phase, the top companies aimed at revenues between US$100 and US$200 million.
• The current round of consolidation began in 2005. Since Lionbridge and SDL made their high-profi le acquisitions in 2005, there have been many smaller acquisitions. TDC has been especially active, purchasing ArchiText, Crimson, and iSP. Welocalize snatched up Connect Global, M2 (2006), and Transco. Across the pond RWS acquired Eclipse and euroscript bought eurodoc. In some cases, they bought specialty capabilities (for example,

ArchiText’s methodology), in-China expertise (Transco), or a foothold in Europe (Connect and iSP). UK’s thebigword also shelled out for China, buying Rainbow in 2006. While some acquisitions remain separately branded, they do roll up their revenue to a bigger company. In this round, the leaders are competing to become the first billion-dollar company, while the followers shoot for the quarter-billion mark.

BALKANIZED FOR GOOD REASONS

The LSP market is often characterized as balkanized or fragmented. The industry provides a wide range of language services, with the individual firms focusing variously on translation, localization, interpretation, or all three segments. There are literally thousands of players, ranging from the largest firms with thousands of employees to the middle market of firms with US $20-100 million in revenue to tiny mom-and-pop shops with just one or two employees. But it is an interesting market to observe given its evolutionary state:

• The top suppliers account for too little revenue. The 20 largest LSP’s booked just 18 percent of the US $9.4 billion revenue earned by the industry in 2006 (see Figure 1).(4) That means thousands of smaller firms brought in the balance of that nearly $10 billion dollars in annual turnover.

FIGURE 1: MARKET SHARE OF THE TOP 20 IN 2005 AND 2006

SOURCE: COMMON SENSE ADVISORY, INC.

• Each acquisition generates 10 new language service providers. With each purchase of an LSP, staff from the acquired firm tends to get squeezed out or find their roles diminished to the point of meaninglessness - so executives and operational managers start their own agency because it’s sometimes easier than finding a job with another company. Barriers to entry are low, although ongoing operations prove more diffi cult to manage.(5) Their desire to keep running the show perpetuates the cycle of balkanization. Meanwhile, many translators dream of hanging out their own shingles to yield more than the pauper’s share of translation fees that a freelancer receives.
• The diverse needs of clients perpetuate the fragmentation. Every buyer needs something different. Some are public agencies, most are commercial operations; some jobs are big, many are small; some firms are satisfi ed with just Asian tongues, others demand 36 languages from around the world; some need very specialized work, others rely on generalists. This is also why the market is so compartmentalized. It’s not just about market effi ciency, but also about the various needs being filled - from provisioning service departments to enabling global brand management to powering customer experiences across the planet.

Dilemma: Artificial Short Supply Stymies Big Demand- With thousands of companies operating in this industry, we always wonder why there isn’t more M&A. The reason lies in the mismatch between buyer and seller requirements and expectations.

• Demand. LSP’s are growing to meet client demand. Besides that, they have to grow to generate the returns expected by the financial markets or their ambitious investors. Thus, they have to produce more new business than they can generate organically. Smaller firms crow about their success in doubling turnover from a base of US $1 million, but sustaining that rate to leap from US $50 million to US $100 million is impossible unless they take the M&A route.
• Supply. Lots of companies tell us they want to buy, but we find that very few of the smaller service providers want to sell. The big obstacle here is that owners of LSP’s harbor unrealistic expectations about the worth of their firms. We have had LSP’s tell us that they would consider selling out for two- to threetimes leading (that is, this year’s projected) revenue. One company told us that it would start conversations if and only if someone paid five times revenue. Given the multipliers that the market pays for human-delivered services companies, these expectations don’t jibe with reality.(6) Traditional market valuations for LSP’s fall in the range of 0.7 to 1.2 times revenue.

MORE M&A? IT’S A WAITING GAME

There are many prospective buyers and few sellers right now. In today’s climate, Common Sense Advisory thinks there’s a low likelihood of any company rolling up the language services market. What will move the market and change our prediction could come at any time. Any of several trigger events would signal boom times for M&A specialists: 1) A transaction for an LSP closes at more than six times EBITDA; 2) Lionbridge earns an appreciable profit for three quarters in a row; or 3) a flashy LSP with offshore operations and spiffy offices in London or New York IPO’s on a toptier stock exchange with resplendent publicity fireworks.

Any one of these events could happen in the next 18 months - or not. If any of them do and the word gets out, we think there will be a rush to buy LSP’s.

ADVICE TO BUYERS OF TRANSLATION SERVICES AS THE MARKET

CONSOLIDATES

Mergers, acquisitions, and other market consolidations are a fact of life. That said, there are a few things you can do to protect yourself and your company from the vicissitudes of the free market:

• Think ahead. Add a clause to your service agreement that lets you rescind your service agreement in case somebody you don’t like buys your supplier. Consult with an attorney about other remedies that you could write into the contract.
• Ask for the moon before the fact. When they are in the due diligence process of being acquired, most suppliers will schedule conversations with key clients. This is the time to ask for guarantees and service improvements. Clients usually don’t ask for much. They might say that they like their project manager and don’t want him or her to change. Ask for more.
• Be vocal after the fact. As the acquiring company rationalizes the two businesses by eliminating jobs and overlap, somebody - or lots of people - inevitably get fired, moved, or somehow diminished. For example, we’ve seen clients angered because their account teams were moved from one coast to the other or from the U.S. to Montréal or Dublin. If this matters, let them know that you’re not happy.

Renato Beninatto is the vice president of consulting for the research and consulting firm Common Sense Advisory (http://www.commonsenseadvisory.com). He can be reached at renato@commonsenseadvisory.com.

(ENDNOTES)

(1) "Developing Products for Global Markets," Common Sense Advisory, June 2006.

(2) "Ranking of Top 20 Translation Companies," Common Sense Advisory, May 2007.

(3) "Consolidation in the Language Services Market," Common Sense Advisory, July 2007.

(4) "Ranking of Top 20 Translation Companies," Common Sense Advisory, May 2007.

(5) "How to Avoid Getting Lost in Translation," Common Sense Advisory, December 2003.

(6) "Lionbridge 2005: Opportunities and Challenges," Common Sense Advisory, September 2004.

ClientSide News Magazine - www.clientsidenews.com