Presented with an Investment Opportunity in Managed Services?
Secure. Convenient. Cost effective. Always on. There is a lot to like about managed IT service providers (“MSPs”), and recent M&A activity in the space would suggest investors agree. As enterprise clients continue to shift their IT spend from Capex to Opex, MSPs should continue to generate greater investor attention.
As with any due diligence process, investing in an MSP requires a careful understanding of the space and the target company under review. With this in focus, investors should consider/answer the following three questions at the outset of their diligence processes.
“Pure-Play” or “Broad-Based” MSP?
Some MSPs offer the complete outsourcing of IT operations to a range of end markets. This “Broad-Based” approach can often lead to increased competition on the basis of price. Other providers operate with a niche focus. These “Pure-Play” MSPs are often providing fewer, highly tailored services to a narrower range of end markets. This specialization often results in a stickier customer base, and the ability to sustain higher margins. As a result, “Pure Play” MSPs are often generating premium valuations relative to “Broad-Based” players. Regardless of the approach, investors should carefully study the target’s business model to understand its unique value proposition and ability to generate and sustain attractive margins.
As investors look into retention metrics, they should examine the employee and customer base simultaneously. The quality and tenure of the employee pool will impact customer retention. At the same time, the demands of the customer pool will impact employee retention. This can become a self-fortifying cycle in many industries, especially in managed services. Not surprisingly, the quality of the company’s personnel drives operational efficiency, and in the managed services industry this means reaping more when sowing less.
What will enable further growth?
MSPs will have many opportunities to grow, but the question is how they’ll get there. For some, it’ll be an easy journey; for instance, a few organizational tweaks might allow for more sales’ wins and higher utilization. But for others, it won’t be as easy; for instance, some may have to make costly hires in order to support a growing customer base. Investors should carefully consider the incremental investment that will be needed to take the target to the intended destination, and whether or not the existing organizational structure is aligned to support that growth.
In any investment process, a few simple questions at the sourcing stage can save headaches later on. In the managed service industry specifically, carefully thinking through the business model, the customer and employee retention picture, and the roadblocks to growth will help investors as they navigate a complex and changing managed services landscape.