IT services M&A slows, but could revive in 2H

M&A rebounded after the initial shock of COVID-19, but the pace has slackened amid economic uncertainty. The deals getting done reflect interest in specific skill sets.

The tempo of IT services M&A slowed in the first quarter, continuing a dip in deal volume that began in the latter half of 2022 as inflation rates and recession fears surged.

The trailing off of transactions follows a strong M&A run in 2021, as the COVID-19 pandemic abated, that spilled into the first months of 2022.

Alec Dafferner, partner and head of U.S. advisory at GP Bullhound, a technology advisory and investment firm, said many of the companies he's talking with suggest it will be 2024 before they look to make acquisitions. He said signs of a slowdown surfaced last year: GP Bullhound's Q4 2022 digital services sector update cited 551 transactions in the first half of 2022 and 448 in the second half, a 19% decline. The digital services category includes cloud consultancies, MSPs and social media agencies. GP Bullhound plans to post Q1 2023 numbers by mid-April.

Aventis Advisors, an M&A advisory firm based in Warsaw, Poland, points to the same trend. The company said IT services M&A transactions grew at an average annual growth rate of 8% between 2015 and 2021, but fell 16% in 2022. "The challenging macroeconomic outlook caused buyers to adopt a more conservative strategy, placing a higher premium on cost savings and organic growth rather than expanding through M&A," the company's IT services market analysis stated.

A rebound ahead?

Buyers might wait for the business climate to improve before plunging into M&A in a big way. But with 2024 potentially the year when M&A kicks off again, some companies could return to deal-making by the end of this year.

"There will be a lot of deal traffic, so let's do something in Q4 2023 to get into the market a bit sooner," Dafferner said, describing the thinking of some potential buyers.

If the economy's fundamentals stabilize and show signs of improvement over the next quarter, more deals could indeed emerge later on in 2023, he noted. The banking crisis, however, could dampen enthusiasm. "It is uncertain if it's going to have a big impact into the back half of the year," Dafferner said.

Chart of recent IT services acquisitions from Q1 2023.
Recent transactions reflect interest in AI, data science and specialized cloud skills.

But bank failures aren't affecting the MSP portion of the broader IT services market, according to Abe Garver, managing director and MSP team leader at Focus Investment Banking, an M&A advisory firm with headquarters in Vienna, Va.

From Garver's point of view, the key issue isn't the economic climate, but a mismatch of supply and demand. He said 69 private equity (PE) groups are looking to invest in an MSP platform, while 70 other groups are looking for companies they can add to existing platforms. But enticing acquisition targets are in short supply.

"Relatively speaking, there are very few good-quality assets," Garver said.

The greatest unmet demand for platform MSPs is at the $5 million earnings before interest, taxes, depreciation and amortization (EBITDA) level, which MSPs struggle to reach without PE backing, Garver said.

Garver's company helps engineer merger-of-equals deals, in which MSPs of similar size gain an aggregate EBITDA that makes them more attractive to buyers.

Deals still getting done

While those developments get sorted, some IT services deals continue to get done. IT services transactions thus far in Q1 revolved around specific skill sets and areas of vertical market expertise. Accenture last week said it agreed to buy Flutura, a company in Bangalore, India, that specializes in industrial AI. Flutura employs 110 professionals offering data science services for manufacturers.

Accenture adds here, cuts there

While Accenture adds resources for AI-led business transformation, the professional services firm also aims to trim its employee roster.

Accenture last week said it is cutting 19,000 positions, or 2.5% of the company's workforce, over the next 18 months. More than half of the employees affected work in "non-billable corporate functions," according to Accenture's 10-Q filing.

While Accenture reported record new bookings for its fiscal second quarter that ended Feb. 28, the company slightly cut its fiscal 2023 revenue growth projection to between 8% and 10%, from the previous 8% to 11% guidance. Accenture cited inflation, which has put pressure on IT services costs, rather than weakness in demand as motivating layoffs.

In an earnings call, Julie Sweet, Accenture's CEO, cited "wage inflation like none of us have ever experienced," noting that the workforce reduction provides a way to "more structurally address" that trend.

AI and data science ranked among the top areas of interest for Q1 IT services buyers. Other sought-after skills included IoT engineering, DevOps and SaaS platform consulting.

Dafferner cited WPP's acquisition of Goat, an agency focused on social media and influencer marketing campaigns. GP Bullhound advised Goat in that deal, which closed last week.

In situations where you have a good fit, deals are still getting done, but it is a bit more narrow -- tactical negotiations versus broader auction-style processes.
Alec DaffernerPartner and head of U.S. advisory, GP Bullhound

"In situations where you have a good fit, deals are still getting done, but it is a bit more narrow -- tactical negotiations versus broader auction-style processes." he said.

In addition, buyers continue to show interest in companies with vertical market, e-commerce and digital retail specializations, Dafferner noted.

As for vertically oriented deals, Optiv, a cybersecurity company in Denver, earlier this month acquired ClearShark, a cybersecurity reseller. The deal more than doubles Optiv's federal presence, according to the company. Kevin Lynch, Optiv's CEO, described the acquisition as "expansionary" and one that will open new opportunities for the companies and their partners.

Other deals are in the works. Garver said he is working with four or five MSP assets that will be coming to market over the next few weeks. Several buyers last week submitted bids to purchase one such asset through an auction process. "We got a lot more bids than we were expecting," Garver said.

The competitive bidding process can improve the multiples for which an MSP sells. Garver estimated median multiples of seven times earnings before EBITDA for an add-on acquisition target, 10 times for a first PE-backed platform investment and 15 times for a recapitalization with a larger PE firm. An auction could add up to 1.5 to those multiples versus deals in which the seller negotiates directly with the buyer, Garver said.

Dig Deeper on MSP mergers and acquisitions

Cloud Computing
Data Management
Business Analytics