Russia’s invasion of Ukraine and the ensuing escalation of events, including sanctions and other measures levied by leading economies including the UK, EU and US, have led to a critical geopolitical inflexion point.

As restrictions eased the UK’s economy looked primed for recovery, with sectors rebounding, labour tightening, prices soaring, and the Bank of England poised to begin unwinding the fiscal policy and monetary support they initiated during Covid-19. The Russian invasion of Ukraine will materially hinder the UK economic recovery, presenting new hurdles to overcome and bestow further stress on the UK’s economy.

The macro impact of the military conflict will be felt across multiple channels. Commodity price shocks will exacerbate inflationary pressures with supply constraints to remain challenging. Financial repercussions from the sweeping new sanctions may lead to financial market volatility and reduced market confidence. Potential security challenges may arise in a scenario of an escalating military conflict or via cyber attacks.

Russian aggression will likely result in heightened upward inflationary pressure and a moderate hit to GDP growth over the coming periods. While the prospect of further commodity, and energy, price hikes sharpens the dilemma facing the Bank of England’s Monetary Policy Committee. The Committee must evaluate the short-term impact of increased commodity prices on domestic inflation against corresponding risks on demand.

Potential Impact on UK SITS Companies

In this extremely fluid environment, the evolving geopolitical scenario will undoubtedly affect the UK’s SITS market given the elevated cyber security threats, tech-talent migration and stringent sanctions implemented by the government.

Ageing IT infrastructure and growing service demands, coupled with cloud adoption and evolving market dynamics, have resulted in cybersecurity rapidly climbing the corporate agenda. Combined with recent events, companies are now rapidly evaluating their exposure to the crisis as the military conflict is raising the risk, frequency and complexity of cyber attacks. Given the digitisation and interconnectedness of global markets, cyber attacks can have unintended and damaging consequences for a wide range of sectors across broad geographies. Following Russia’s unprovoked, premediated attack on Ukraine, the National Cyber Security Centre has called for organisations to bolster their online defences, citing the use of HermeticWiper and WhisperGate malware against Ukrainian organisations as of particular concern. Additionally, demand for effective AML/KYC software is expected to witness a significant increase as a result of heightened due-diligence and audit trail processes as the government looks to increase transparency with the likes of the newly introduced Register of Overseas Entities. The unfolding acts of aggression towards Ukraine will provide sectoral tailwinds for cybersecurity companies as organisations scramble to mitigate cyber security risk. In terms of M&A, increased demand is expected to fuel the continued appreciation of deal volumes and values as strategic acquirers look to onboard capabilities and consolidate while financial acquirers look to gain exposure in the sector, providing a window of opportunity for shareholders to crystalise value at elevated levels.

The crisis will likely fuel a tech-talent migration as Ukraine, pre-invasion, was one of the favoured destinations for global tech companies. The abundant availability of skilled talent resources and low cost of living attracted many leading tech companies to off-shore and near-shore third party capabilities to the likes of EPAM, Softserve, GlobalLocic and Luxoft – alone providing over 30,000 senior IT engineers to global organisations and it’s forecast that 170,000 Russian IT specialists could migrate from the region by April. Consequently, as both the war and service market disruption are occurring at the same time as a wider global talent shortage. It’s forecast that, with the strain already provided by the global talent shortage coupled with the additional strain of war on skilled IT resource, the cost of IT talent will further increase, adding to the strong inflationary pressure. The talent exodus is expected to result in UK companies migrating out-sourcing and near-shoring capabilities to alternative hubs like India and Argentina, however, the migration provides uncertainty surrounding quality, costs and increased longitudinal dispersion.

Overall, whilst process timetables may become extended due to altered due diligence scopes and increased scrutiny, the effects of the crisis on the UK SITS M&A market are expected to remain minimal, and potentially act as a growth driver for domestic transaction volumes and buoy market valuations due to elevated cyber security demands.

Potential Impact on SITS M&A

The crisis may alter the deal-making environment as market confidence and volatility may fluctuate. The macroeconomic pressures and geopolitical developments that continue to evolve will inevitably weigh on deal making in the near-term with acquirers re-assessing their acquisition pipeline and risk appetite. Demonstrated by Spectris PLC terminating their discussions regarding a possible £1.8bn acquisition of Oxford Instruments PLC due to economic uncertainty resulting from Russia’s invasion of Ukraine.

The United Kingdom’s sweeping sanctions on Russia means heightened due diligence is required of any Russia-related transactions to ensure compliance with the UK’s regulations. Companies transacting internationally should be aware of sanctions and regulations imposed by other nations related to Russia. For instance, Citigroup’s sale of its Russian business to Russian state bank VTB is expected to hit a roadblock and Roman Abramovich's well publicised exit of Chelsea F.C is expected to face heightened scrutiny in-light of current and evolving sanctions.

To address due diligence challenges, acquirers and targets should consider extending diligence timelines and ensure that due diligence is conducted through a prudent manner and scope. The newly defined diligence scope is expected to extend to business continuity and operations, insurance, supply chain risk, solvency risk, risk perpetrating to material contracts, and alterations applicable to national and international laws. Governmental considerations should be accounted for as volatile geopolitical conditions and evolving international sanctions will lead to an increased number of regulatory considerations when completing M&A transactions, resulting in prolonged transaction timelines in-light of newly defined scope and increased scrutiny.

Russia’s invasion will clearly have profound effects on ESG framework from both the social and governance perspective. MSCI and Fitch, ESG research houses, have downgraded Russia from an ESG perspective and assigned the most severe classification for ESG governance to the Russian Federation. ESG downgrades have extended to the MSCI Russian IMI Index and leading private companies. Given current sanctions, volatile geopolitical conditions and the fact that Russia will be excluded from policy benchmarks, will result in dire economic conditions for Russian companies and make the region un-investable. In-light of the sanctions, leading corporate entities have also began divesting activities from Russia, with BP exiting its position in Rosnet, Shell exiting its joint venture with Gazprom and TJX divesting its stake in Familia. Whilst it’s currently hard to foresee the exact consequences for UK companies, businesses should examine their exposure to Russia and ESG framework with greater consideration, as ESG credentials are being increasingly examined as a component of due diligence exercises and investment appraisals, providing a method to unlock shareholder vale enhancement.

Since the conflict began and the subsequent imposition of strict sanctions by leading economies, macroeconomic and credit implications have impacted capital markets for many nations. However, British financial intermediaries appear to have low exposure to Russia, and therefore remain well insulated from material financial ramifications arising from imposed sanctions. Nevertheless, given the BoE rhetoric pre conflict, subdued consumer sentiment, increased market volatility and commodity price hikes will fuel upward inflationary pressure and scope for additional interest rate rises in the near-term as the crisis exacerbates the tightening policy environment. In an indication of just how pervasive the pressures are likely to be, economists are increasing their inflation forecasts for leading global economies, including forecasts for the UK’s inflation to reach 8% this Spring. The upward inflationary pressure could result in UK companies accelerating fundraising activities in an attempt to capitalise on the relatively low cost-of-capital, before further rate hikes are delivered and the cost-of-capital increases. However, the long-term implications are forecast to remain relatively limited as the capital markets are expected to evolve with geopolitical conditions and inflation is expected to return to the BoE’s 2% target within 2-3 years.

While the crisis will present short-term hurdles for UK SITS companies to overcome, the net-effect of Russia’s invasion on is yet to be seen as the fluid geopolitical environment remains volatile. It is anticipated that the tech talent-migration and heightened cyber security risk will result in the most significant disruption for the sector.

If you would like to arrange a call to discuss the current market trends and/or the opportunities available to create, augment or realise shareholder value, please contact a member of the Software & IT Services sector team.