Report: M&A May Slow Down In 2023, But Not For All MSPs

‘In the housing market, what happens when interest rates go up is house prices go down and there’s less activity in the housing market. It’s safe to assume that that’s probably going to happen in the IT services space with M&A in 2023. The possible exception is with these MSPs that got all that recurring revenue because they’re just so hot,’ says John Holland, managing director of Corporate Finance Associates.

After two high-performing years in the mergers and acquisitions sector, John Holland believes the IT services industry may see a deal activity downturn in 2023, but not for all MSPs.

Holland, who is the managing director of Corporate Finance Associates, predicts that MSPs with high annual recurring revenue may be spared during a possible economic downturn.

“In the housing market, what happens when interest rates go up is house prices go down and there’s less activity in the housing market,” Holland told CRN. “It’s safe to assume that that’s probably going to happen in the IT services space with M&A in 2023. The possible exception is with these MSPs that got all that recurring revenue because they’re just so hot.”

Laguna Hills, Calif.-based Corporate Finance Associates is an investment banking firm with decades of experience in executing mergers and acquisitions in the IT and telecom services industries.

And according to its latest report, “Mergers & Acquisitions in the Technology Services Industry in Q4 2022,” the numbers seem to show a shaky 2023 and, possibly 2024, but not for all in the IT services space.

“Across all industries we do see some slowdown in M&A, but there are some sectors in the IT services space that are defying gravity right now, because they’re just so hot,” Holland said. “IT is no longer in its own box, it touches everything. M&A activity in the technology industry reflects that.”

Last year, Holland said there was a “little bit of a slowdown,” because the Federal Reserve started increasing interest rates, and kept doing so throughout the year.

“So the outlook for 2023 is interest rates are much higher now than they were a year ago and the Federal Reserve is committed to continuing to raise interest rates at least a couple more times, so that makes it more difficult for companies to make acquisitions,” he said.

When interest rates were lower in 2020 and 2021, it was the “rocket fuel” for mergers and acquisitions, he said.

The number of IT services M&A transactions went from 435 in 2020 to 675 in 2021 to 656 in 2022, according to the report. The company with the most M&A deals in 2022 was Dublin, Ireland-based Accenture with 25, followed by The 20 MSP and Upstack with 12, and Converge Technology Solutions and Ernst and Young with 10. The aggregate value of IT service M&A transactions went from $36 billion in 2020 to $72 billion in 2021 to $51 billion in 2022.

The hardest hit companies though may be VARs, he predicts.

“The types of businesses I think that are going to suffer in M&A and that are not going to attract as much interest, or that are going to go for lower values, are the value-added resellers that work on a project-by-project basis,” he said. “These businesses are not as attractive to acquirers because they’re riskier to a recession. If the economy slows down, and if interest rates are up, then you’ll see less activity in M&A concerning VARs.”

CRN spoke with Holland about the M&A environment, how it’s changed since the pandemic and what we can expect to see over the next year.

The report says M&A activity peaked in 2021 and saw a slight decline in 2022, but it was still greater than pre-pandemic levels. What is that attributed to?

In an effort to avert a pandemic-driven recession, the US, Canadian and other governments around the world executed very aggressive fiscal and monetary policies throughout 2020, 2021 and 2022. Those policies provided vast liquidity and unusually low interest rates that fueled M&A transactions during those years to a level vastly above the pre-pandemic level. Also, the pandemic propelled certain types of IT services companies, such as the companies that provide unified communications-as-a-service (UCaaS) and cybersecurity solutions for remote workforces. Such companies attracted a surge of capital from acquirers in 2021 and 2022.

How did the pandemic affect M&A activity over the last 2-3 years?

When the pandemic shocked global capital markets in March 2020, acquirers around the world stalled or terminated M&A negotiations. Consequently, the volume and aggregate value of M&A transactions plummeted across industries around the world in Q2 2020. For example, according to FactSet, the aggregate value of M&A transactions in the North American IT services industry plunged from $7.8 billion in Q1 2020 to $528 million in Q2 2020. As fear in the capital markets dissipated in the summer and autumn of 2020, the global stock market soared and the volume of M&A transactions surpassed the pre-pandemic levels. Though 2021 was an extraordinary year in terms of M&A volume, which increased 55 percent from 2021 to 2022.

What stood out to you the most about the 2022 M&A activity in technology services?

There has been a confluence of industries rushing into the IT services space over the past few years. For example, accounting firms acquired a multitude of IT services companies in 2022. Such accounting firms have been acquiring IT services firms specializing in data analytics, cybersecurity, ServiceNow solutions, Salesforce solutions, and cloud solutions.

The most prolific acquirer in 2022 was Accenture. That global consulting firm seems to be on a drive to dominate certain areas of the IT services industry, such as big data and cloud solutions. Meanwhile, overseas firms have been acquiring North American IT services firms. Then there‘s other big consulting companies and engineering companies that are trying to go into the IT space.

You said outside companies, like engineering, are getting into the IT space. Why do you think that is?

Some of these companies who do construction engineering or build nuclear power plants, they’ll design physical security for a nuclear power plant or whatever. And I think that they‘ve decided that it’s important to go into cybersecurity because it’s related to that of physical security. We see a little bit of that going on.

Do you think more and more industries outside of IT will do this, because of cybersecurity?

I think what‘s happening is just technology is permeating into all sorts of industries and all sorts of aspects of society. One example is the internet of things. There are these consultancies that focus on factory automation, and now they’re really excited about the internet of things. When you‘ve got the internet of things managing these factory processes, then you’ve got a security risk. So they have an imperative to get involved in cybersecurity. It‘s just that there’s a confluence of things. IT is no longer in its own box, it touches everything. I think the M&A activity reflects that.

What should we watch closely regarding M&A activity in IT services in 2023?

The great “land grab” of MSPs will likely continue in 2023. So many private equity firms feel an imperative to be in that MSP space. Larger MSPs are backed by private equity firms that are highly motivated to scale these recurring revenue businesses through acquisition. Similarly, the “land grab” of telecom agencies will continue.

The common thing between MSPs and these agencies is that they all have recurring revenues. It‘s not this project-by-project kind of stuff, and acquirers are very attracted to recurring revenues. Typically a MSP will have three-year contracts with clients so that business is pretty safe for three years, even if there’s a recession. It‘s very difficult for the end customer to divorce itself from a MSP, so that makes these companies very valuable. A lot of acquirers out there are hunting for these kinds of companies. I think that will continue regardless of the state of the economy.

What do you expect to see regarding technology services M&A activity in 2024?

Our crystal ball is awfully foggy about 2024. The direction of interest rates at the end of this year will influence the M&A trends in 2024. The Wall Street consensus is that the Federal Reserve will begin reducing interest rates in late 2023 or early 2024. Therefore, 2024 might be a year of intense M&A activity. As we discussed earlier, regardless of the interest rates, there will be compelling reasons why private equity firms and large corporations will conduct M&A transactions in 2024 and beyond, especially in the higher growth areas such as cybersecurity.

Could you compare it to 2008? Is there anything we can learn or look back on what happened in 2008 and how we came out of that recession?

We don’t know if there will be a recession in 2023. And if there is, we don’t know how bad it will be. Normally what happens is you see the IT services companies stop growing in terms of revenue and the customers start pulling back, cutting their IT budgets. That makes it harder for that IT services company, whether it‘s a VAR or professional services firm, or whatever, to sell the business because the buyer uses a trailing 12 months, TTM, of financial performance to determine the valuation the business. So if the business starts declining because of the economy, and you don’t know how long it‘s going to go down and how bad the recession is going to be, then acquirers are much more careful. They’re not going to offer as much money for businesses in that environment.