IT Services Industry Surfing M&A Consolidation Wave

By Cristian Anastasiu and Michael Schwerdtfeger

Whether yours is a small, midsize or large IT services firm, and whether you sell products, provide services or a combination of both, you’ve undoubtedly felt some seismic shifts in the past few years as competitors and collaborators rapidly buy, sell and merge. You likely also have a variety of pressing questions: How do I survive the turmoil? What do these changes mean to me? Should I consider pairing up with another firm? How do I prepare for such a transaction? How do I determine the right timing? How do I find and select the partner to which I represent the highest value?

Hopefully, over a series of articles, we’ll answer some of these questions and provide background that will assist you in planning your firm’s future.

First up: Why is this happening now?

For one, IT services are maturing and becoming commoditized. Continued growth requires management acumen and capital, and often, having one is dependent on the other. Maturation also brings opportunities to apply economies of scale to the business. As a result, strategic buyers within the industry, as well as institutional investors, have applied their knowledge to IT services, resulting in a rapid scaling of the sector.

In addition, we see two market paradigms converging. Legacy VARs and systems integrators have historically led their sales and business development with products from partners, such as Cisco, HP, EMC and Dell, and today most still derive 60 percent to 70 percent or more of revenues from product sales. However, these firms are having a hard time transforming themselves into managed services providers because of the very different business model and company culture required.

At the other end of the spectrum are thousands of companies with strong service cultures generating revenues of $5 million or less from services and recurring work. These companies typically lack sales expertise and manufacturer relationships; as a result, they tend not to participate on the front end of major new technology rollouts (products and services) at potential or existing clients.

These VARs and MSPs have natural chemistry.

Meanwhile, new players have entered the IT space in recent years, attracted by a growing market with higher margins than their original businesses. Think distributors, such as Insight and Arrow; printer and camera manufacturers, like Ricoh, Konika and Xerox; and even electronics manufacturers moving into technology. And, with the latest cloud-related developments, IT services firms that have played at the application layer are becoming interested in infrastructure managed services firms, where they can apply their more mature organizational structures.

An additional consolidation driver will be MSPs and systems integrators adding application-layer capabilities. This is especially true for companies focused on vertical markets, such as financial services, K-12, health care or government, where firms are vertically integrating with the goal of offering complete solutions from infrastructure to applications — and where the cloud is the linking factor.

In addition, in previous cycles, companies largely grew organically or via acquisitions based, to a large extent, on geography. Most firms started locally and used acquisitions to logically build out territories. Recently, however, we see buyers focusing more on skill sets, cultural fit and synergies, resulting in multiple acquisitions, even of smaller companies, that are geographically separated from the buyer.

Succeeding in this fast-moving environment requires that firms understand the M&A market, its dynamics and the opportunities. But make no mistake: Consolidation will continue, whether entrepreneurs understand their long-term options or not.

The Arrival Of Institutional Capital

As industries mature, they move from an entrepreneurial stage to a more institutional mindset. In today’s terms, this shift becomes obvious when institutional capital, funneled through private equity groups, floods into a sector.

While private equity firms have been buying and growing companies in the IT services space for a long time, some recent transactions highlight the growing role of institutional capital. Recently, publicly traded private equity firm Apollo Global Management acquired IT services provider Presidio Holdings for well over $1 billion. Reportedly, Presidio has 2,200 employees and generates about $2.4 billion in annual revenue. Interestingly, Apollo acquired Presidio from American Securities, another private equity firm. Similarly but at a slightly smaller scale, ConvergeOne, one of the largest Avaya channel partners in the world, was acquired by Clearlake Capital Group in 2014 from Genstar Capital, which acquired the company in 2007.

The most important takeaway here is that these institutional investors are diving deeper and deeper into the channel. Private equity firms (and portfolio companies owned by private equity firms) are making acquisitions throughout the marketplace, all the way down to companies with seven-figure revenues.

We expect that trend will continue throughout the IT services sector and in all facets of the industry, largely due to factors we will address in next month’s article.

As noted, consolidation efforts began with large systems integrators, where scale was easy to apply. However, as more professional investors jump into the space, the market will continue to push opportunities downward to the point that now, many midsize providers have been acquired by, or are on the radar of, professional investor groups looking to grow. Consequently, the next round of opportunities will involve even smaller companies being brought into the fold.

Cristian Anastasiu and Michael Schwerdtfeger are managing directors at Chapman Associates, a national mergers and acquisitions firm providing middle-market companies across various industries with the same resources, expertise and representation that is usually available only to much larger companies. Michael’s e-book “The Inner Workings of a Deal: Tips for a Successful Transaction” is now available for free download. Follow them on Twitter at MBSMergers.