As digital technology continues to transform how business is done, the complexity and speed of change of information technology continues to increase dramatically. Many businesses realize it is impractical to invest in the required personnel and training needed to stay on top of the latest developments in technology. As a result, many companies, particularly small- and medium-sized businesses, rely on third-party service providers to install and manage their IT systems. The growing demand for these outsourced services has caught the attention of both strategic acquirers and private equity funds looking to capture share of a burgeoning global market, which is expected to grow at an average annual rate of 8.4% and reach $1.1 trillion by 2025.(1)
Supply and Demand for the M&A Market
Acquirer and investor demand for IT Services businesses remains high due to several factors:
- The large, fragmented and expanding industry offers an opportunity to grow both organically and through acquisitions;
- Demand for IT services is steadily increasing;
- Recurring revenue generated by managed services’ contracts provides visibility into future performance; and
- For strategic acquirers, consolidation provides an opportunity to expand technical and sales resources, access new customers and broaden service offerings.
In addition to being extremely large, the IT Services industry is highly fragmented with over 450,000 industry participants, which provides an ample supply of potential sellers for the M&A market. Industry fragmentation is expected to increase slightly as new participants regularly enter the market and often specialize in recently introduced technologies and emerging trends. However, the number of new entrants will be offset by large industry players continuing to acquire successful niche companies to add new capabilities and customers.
Key Value Drivers
Although both the supply of IT Services businesses and the demand from acquirers remains robust, not all sellers are created equal. Numerous attributes combine to determine how much a business is worth. For IT Services companies, several key value drivers are:
- Recurring revenue – revenue derived from managed service contracts adds visibility to near-term financial performance. Sellers with a high percentage of recurring revenue will be considered more attractive than companies with solely project-based revenue.
- Size and scale – companies that have achieved earnings before interest, taxes, depreciation and amortization (“EBITDA”) of at least $5 million will see significant interest from strategic acquirers and private equity firms, as companies of this scale are considered less risky than smaller firms.
- Customer diversity – a highly diversified customer base helps mitigate risk due to potential customer losses.
- Attractive financial profile – firms growing faster than the overall industry and those generating above average profit margins due to sustainable advantages will be considered highly attractive acquisition candidates.
- Sector expertise – niche focused firms, especially those with focus on a fast-growing market segment, will receive significant interest from both financial and strategic acquirers.
Cybersecurity is Hot
As mentioned above, sector expertise can be a key differentiator for a potential seller. One area that is hot right now is cybersecurity. As the attention on cybersecurity continues to heighten, the focus on how IT solutions can mitigate the risk of a security breach will intensify. Recent cyberattacks at large, reputable companies like Equifax and Capital One have prompted businesses to take a proactive approach in evaluating the security of their IT infrastructure and systems. The acquisition of SLAIT Consulting by ePlus is one of many deals this year that involve a strategic investment in an IT Services provider offering managed security services. A few other security-related deals include Rook Security being acquired by Sophos, Nuspire acquiring GBprotect, and Corsica Technologies acquiring EDTS Cyber and EDTS.
Implications for future M&A
IT Services is a large, growing market that will continue to attract investors and acquirers. MHT Partners, a leading technology investment bank, believes companies offering differentiated IT services and technology solutions will be highly attractive in the M&A market. If you would like to learn more, please contact Mike McGill (firstname.lastname@example.org) or Kevin Jolley (email@example.com).