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Cloud Gazing with WTA Partners: the significant increase in UK MSP M&A - why and what it means to those involved
The move to the cloud has been
accelerating driven by companies seeking long term benefits, massive investment
from the hyperscalers, the move to digital transformation and competitive
vendor pricing. The arrival of Covid led to increased demand for secure and
reliable systems for home and remote workers and greater need to for digital
transformation. During this time M&A activity in the sector increased
To gain an understanding of both the current state of the market
and the character of emerging trends WTA Partners was delighted to welcome a
panel of leading industry figures to a virtual seminar on Thursday 23rd September and an audience of mainly senior MSP executives and private equity
house representatives with an investment interest in the sector.
Why has there been so much M&A activity in the sector
After a brief welcome by Jeffrey Jenner, the first of the guest
speakers Nigel Redwood, former Nasstar CEO and now Cloud Service
advisor, identified four main drivers for this growth in activity: economic;
hyperscaler activity; buyer ambition and seller needs.
Nigel described a ‘perfect storm’ generating high levels of M&A
activity comprising strong growth in global business with Western economies
doing well, low interest rates both encouraging borrowing and discouraging
saving and a wealth of Private Equity (“PE”) capital availability. The last was
particularly important with more of this capital finding its way to the
technology sector as PE was generally avoiding the Covid impaired areas such as
commercial property, retail, hospitality and travel.
Next, he looked to the impact of the Hyperscalers and their multi-billions
of investment providing end users with new opportunities for innovative cost
effective solutions and low capex needs, creating enormous opportunities for MSPs
to meet the growing and more complex demands.
This same opportunity and growth lead to sector skills shortage, for
many a reduction in margin and EBITDA meaning the better funded companies saw part
of the solution in acquisition and synergy savings. At the same time owners saw
it as good reason to exit and not deal with these new challenges just as the
outlook for CGT and Entrepreneurs Relief seemed less benign.
Nigel concluded by showing just how many trade buyers and PE
houses were competing in the sector along with the accompanying level of
M&A transaction activity.
The buy-and-build strategy: an insider’s perspective
Following Nigel, to the virtual podium was Kerv Group CEO, Alastair
Mills, probably the sector’s most experienced M&A entrepreneur having acquired
Alastair raised the importance of the leverage buyout model (“LBO”)
and the necessity of understanding how the LBO model works to perform effective
M&A. He identified the key considerations for achieving equity accretion including
organic growth, cash generation, multiple arbitrage, use of debt and cost
He stated very clearly that the traditional model of M&A activity,
based upon multiple arbitrage, aggressive cost synergy and driven by
opportunism is broken. Instead he suggested seeking longer term goals met by a
more though out and strategic process.
Alastair emphasised too the importance of engaging high quality,
emphatic and effective M&A and legal advisors. Crucially he identified the
importance of “shared and common values” with these professionals and shared
experiences of damage inflicted by overly aggressive legal representation which
alienates and incenses an acquiree by misreading the need for gentle and
measured engagement rather than acting aggressively.
The challenges for a small MSP and why we sold
Matt Newton, MD of Oosha, shared his experience from the
founding, development and growth of the company. He contrasted the difference
between early days of growth moving towards their current position as the
business shifted towards virtual desktop products, managed services and service
desk offerings directed at professional services practices and particularly
solicitors and accountants. Oosha’s
journey included correcting early mistakes, becoming one of the first in their geographical
location to focus on sectors, dealing with the aftershock from 2008 financial
crisis, avoiding a race to the bottom by not competing on price but offering
quality of service, and more latterly, the challenge of scaling operations to
Matt also explored the mindset of the seller, with reference to the
key question: ‘why sell’? To this he pointed specifically to his experiences; the
five founders having different interests and ambitions including some wishing
to retire. After explored partnering with PE, the answer was to sell the business
to a party who would allow those needing to exit to go but provide others, like
himself with ambition, opportunity to grow. Matt was another speaker who highlighted
the importance of engaging the best advisor and specifically, in this case, one
who would be sensitive to the differing goals of each member of the ownership
team and being able to manage the situation.
Why private equity is so keen on the sector
Nicki Boyd, founding partner at Apiary Capital, kindly
stepped in at the last moment when one of her partners had to pull out at the
last moment when his wife went in labour. Not being prepared for this, she did extraordinarily
well in dealing with the topic and describing what the journey would be like for
an investee MSP.
Nicki began by assessing the market including its rapid growth and
high level of M&A activity. She noted over the last fifteen years the convergence
in the sector bringing multiple service line offerings into a single business,
the move to outsourcing and the lack of appetite for end users - customers - to
expand capacity in-house as complexity increased. She then spoke of “The Cloud
migration journey”, moving to an agile process of tailored support for
organisations and how MSP customers tended to be “sticky” so more likely to
‘stick to the provider’. The Covid impact has created a greater attraction from
PE to the space and its resilience. She reinforced earlier comments made that
PE houses had to find ways to deploy capital when a number of sectors turned unattractive.
In terms of what a PE house were seeking was good quality of the
management team particularly if it was a platform investment in which case PE
might look to support and partner with the management team by adding
non-executive directors fulfilling a non-exec role and developing a
constructive dialogue to support this. Also sought were businesses able to grow
along with good quality information to assess the financial and structural
elements of the company.
Nicki concluded by stressing that PE’s interest and capabilities
in the sector might be powerful, but so too is the need to be selective and
informed in targets for investment. From the perspective of the MSP this translates
to robust financial prospects and a clear sense of direction.
What makes an MSP attractive to an acquirer
Jeffrey began the next session by providing a
definition of an MSP and put forward that it must have Annual Recurring Revenue
(“ARR”) greater than 50% and went on to say that the higher the ARR percentage
the more attractive, i.e. valuable, the MSP is. Indeed ARR was a key driver drivers of value.
Continuing, he explained that ‘well-run’ MSPs are achieving EBITDA
margins of 15% so a prospective sellers should be aiming for that level of
performance. The highest achieving close to 25% with those not reaching 10%
probably requiring action but some buyers will see that as an opportunity and
an encouragement to acquirer but will, of course, base valuation on the lower
metric. But as important level achieved
is consistency as that demonstrates sustainability. Next comes the rate of revenue
growth and like EBITDA should be consistent over time. And the
revenue should come from a good spread of customers as high customer
concentration is unattractive. He then added that high customer churn was
particularly unattractive as it was an indicator poor service delivery or out
of date services. It is best that customers
have at least fifty seats for at that level there is more complexity and
complexity is opportunity for an acquirer to sell additional services. Also
important is the size of the business because valuation metrics rise with size.
Moving away from quantitative measures Jeffrey identified having a
strong management team in place increases the attractiveness to an acquirer as
it indicates the business is more likely to be sustainable and have good procedures.
It is also attractive to a buyer as they may see opportunities for synergy
savings. Having both a strong management team together with a good record of
growth make it appealing for direct investment by Private Equity too which
opens up additional possibilities for the shareholders.
Before concluding Jeffrey listed half a dozen further attributes
but these were not as important as those previously described.
Panel Q&A – Questions from the audience
Concluding the day’s events was a lively Q&A; indeed time ran
out before all the questions could be answered. Of particular interest were:
closed the session and thanked the attendees and told them he would be emailing
with details where they (and others) would be able to download the individual
sessions as the event was recorded.
event was recorded and there are individual videos of each session available to
more detailed view of what makes an MSP attractive based on Jeffrey’s
presentation can be viewed or downloaded here
wish to discuss any aspect of the session or indeed any matter do feel free to drop
me, Jeffrey Jenner an email at firstname.lastname@example.org or call 020 37869001.