In the past year companies in the IT sector have returned to a measure of health. Most are profitable again and margins are improving across the board.

The improvement comes on the back of relatively strong growth in the sector. Data from BMI-TechKnowledge (BMI-T), a specialist research firm, shows that the SA IT market grew by 6,1% between 2004 and 2005. BMI-T expects similar growth in 2006. This is slightly above the growth in more developed markets, but lags behind some developing economies, says the firm's IT research manager Roy Blume. IT spending in India, China and Russia is booming. Russia, for example, is enjoying growth of about 20%/year, he says.

Growth in SA is much more pedestrian but is well up on the dark days of 2002 and 2003.

Blume expects the growth to continue. It might even accelerate as government puts policies in place to aid growth in the sector. The 2010 Fifa Soccer World Cup should also give the sector a fillip - billions of rand will have to be invested in new broadcasting and other technologies to meet Fifa's stringent requirements for the event.

Cheaper, more ubiquitous telecommunications - especially broadband Internet access - should also help drive demand for IT services, Blume says.

In another sign of the sector's health, mergers and acquisitions are the order of the day for the first time in years as the stronger players consolidate their positions.

Perhaps the highest-profile example of this new-found appetite is Telkom's R2,4bn bid for technology services group Business Connexion (BCX), this year's top IT company. At the time of writing, Telkom looked set to consummate the deal after a mystery bidder pulled out of the running. The other bidder's name was never revealed, but speculation centred on India's giant Tata group. The names of cellular network operator MTN and international IT services companies T-Systems, Computer Sciences Corp and IBM were also mentioned.

Telkom's deal with BCX must be seen in the context of its search for new revenue streams, as its voice business comes under competitive pressure - from the second network operator and from new technologies such as Voice Over Internet Protocol. The company wants to become what it calls a "leading information and communications technology solutions provider" and BCX would help it do this.

Competitors worry, however, that a deal would be anticompetitive and would damage the sector. Telkom would have the opportunity to cross-sell and cross-subsidise, they say. What's to stop Telkom from offering discounted telephony to a big corporate client in return for a juicy IT services contract?

Telkom is confident the deal will go ahead but competitors are lining up at the competition commission in an effort to have the deal blocked. Complaints have already been filed with the competition watchdog.

If they succeed in blocking the deal, other bidders may be tempted to the table. Bytes Technology Group, which had previously bid R7,60/share in cash and shares for BCX - it was not prepared to match Telkom's revised cash offer of R9/share - could still be interested in a deal, says CEO David Redshaw. But he stresses that he is not prepared to overpay for acquisitions.

Bytes, which is second after BCX in this year's IT rankings, has performed well in the past few years. Under Redshaw's leadership, the company has improved its profit margins and made several clever acquisitions. Perhaps the most important of these was its 2004 buy-out of the troubled CS Holdings.

"It's been one of the most successful acquisitions I've been involved in," Redshaw says.

There's no doubt that Redshaw and his team turned CS Holdings around in record time. The company had been teetering on the brink of bankruptcy but now contributes positively to Bytes's bottom line. The deal gave Bytes a much stronger foothold in the services market and has enabled it to position itself better against BCX and the other heavyweight player in SA's IT services market, Dimension Data.

Competition, however, remains cut throat, keeping pressure on margins. Didata, for example, has met its own targets for its operating margins, but it's only managed to do this through aggressive cost-cutting. Gross margins have remained flat. So, it's still a buyer's market as the big IT companies all fish in the same pool with limited contracts. Sales are rising at the fastest clip in years, but corporate IT buyers remain spoilt for choice as suppliers fall over each other to win new business.

Blume says the pressure on IT companies' margins is unlikely to go away any time soon.

"IT has entered the real world and we have to work for our money now."

The sector, he says, has become more mature. And margin pressure is likely to drive market consolidation further.

"The market isn't big enough to maintain a plethora of large organisations," Blume says. Even the smaller IT services companies have begun coming together to compete more effectively, he says.

There are some areas of the market, though, that are still proving highly lucrative. One of these is offshoring, where international companies outsource certain processes or functions to cheaper territories. And it's an area with almost limitless potential. IBM SA has been the most successful in this regard. It has invested hundreds of millions of rand in an "integrated delivery centre" in Sandton to serve IBM clients in the UK, Sweden, Denmark, Finland, Norway, Belgium and the Netherlands.

Its plans aren't limited to supporting offshore clients. IBM SA Global Services GM Mteto Nyati told the FM earlier this year that the company wants to take on the services heavyweights at their own game.

"We have chosen outsourcing as the area where we need to have a significant presence and become a market leader."

IBM expects its offshoring business to grow exponentially. It plans to hire 900 people this year. A lack of available skills, it says, is the biggest impediment to its ability to expand its operations.

IBM isn't the only company that has enjoyed success in attracting offshoring business to SA. Though giant US Internet service provider America Online recently decided not to renew a multimillion-rand call centre outsourcing contract with Didata, the company has won other business this year. One contract is a multimillion-rand deal with Carphone Warehouse, a large UK cellphone retailer.

In the past, much of this type of business went to India. Government, however, wants to attract more offshoring work and, in fact, has identified offshoring as one of the key factors that will help lift SA's economic growth rate in the years ahead.

Another company that has performed remarkably well in the past year - its share price has left its rivals in the dust - is Datatec.

An investment in this global distribution and services business 24 months ago would have netted a return of 500%.

After years of cost-cutting, Datatec, under the leadership of CEO Jens Montanana, has turned the corner in dramatic style. In the year to February 28, Datatec lifted turnover by 18% to US$3bn. Operating profit soared 532% to $69m, albeit off a relatively low base.

Surprising the market, Datatec also announced plans to seek a secondary listing in London - on the Alternative Investment Market of the London Stock Exchange - with the aim of raising about $100m.

Following the lead of other IT companies, Datatec also announced it would pay a maiden dividend of 30c/share.

In another sign that the IT sector has put its worst days behind it, Montanana says he expects that Datatec's double-digit growth will be maintained.