5 Factors Accelerating the Consolidation Wave

Cristian AnastasiuMichael SchwerdtfegerPreviously, we focused on the M&A wave and the arrival of institutional capital, along with new players in the IT services market, which have driven many years of consolidation in the space. While this backdrop is important, there are a variety of other factors, economic and otherwise, that are also fueling the current fervor in the M&A market in the IT services sector.

Economic Factors: Historically, across industries, mergers and acquisitions have been cyclical. Downturns in the economy generally lead to a tightening of deal making. Once the economy turns around, large corporate buyers typically start the cycle, often with blockbuster deals that create significant changes in a sector’s environment. As the cycle matures, deal opportunities drop down-market as companies and financial players look to backfill the holes left by the initial large transactions. 

2013 was the start of the most recent cycle, with large volumes of blockbuster transactions occurring in the economy. Experts generally concur in their belief that 2015 and (potentially) beyond will continue the cycle, as both corporate and institutional buyers have abundant cash available for further purchases. Pitchbook suggests that private equity has about $750 billion of “dry powder” available for dealmaking, along with a large portfolio of aging companies that will soon result in further liquidity.

Other economic factors support further deal making: Credit is abundant and cheap, with domestic and international interest rates continuing at multi-decade lows. Debt continues to be readily accessible. Lenders are willing to fund transactions at significantly higher valuation structures. The Wall Street Journal reported that in 2014, purchase-price multiples reached 2007 levels, the previous bellwether year.

Technological Factors: Technology changes are also driving continuing consolidation. As the IT market shifts from being product- and computer-centric to cloud– and mobile-based, new opportunities and demand arise for capabilities and skills that were relatively unimportant a short time ago.

As an example, relatively new offerings like managed services, software as a service and cloud are expected to grow by 15 percent to 30 percent annually over the next few years. Consequently, these opportunities are driving transactions that weren’t even on the radar a short time ago.

Demographic Factors: The nature of business ownership is also driving transactions. In the first round of consolidation, in the ’90s or mid 2000s, the founders of early-stage IT service companies were often sales people. Many of these early pioneers already transitioned in the first stage of consolidation. However, the second tier of these pioneers is now aging and looking for exits. Baby boomers who started IT services companies in the early days are now looking to take chips off the table or create a succession plan for their companies.

In addition to the pioneers, a new generation of younger, smaller companies has younger ownership groups. Many of the companies in this new generation were founded by technical experts rather than sales people. Consequently, many are now reaching critical inflection points where management teams are exceeding their own business skill sets and are looking for new resources to grow their companies. These inflection points are significant drivers of deal activity as they provide sellers with the incentive to act.

In both cases, the demographics of the IT sector are such that transactions are likely to continue to be attractive to both founder entrepreneurs and buyers.

Industry Opportunity Factors: The broad range of opportunities presented by IT service mergers also factor into the number of transactions.

As opposed to product-based technology companies, which are often highly specialized and with a narrow scope that leads to few potential buyers, IT services companies tend to provide broad opportunities. There are many characteristics and infinite combinations of what might attract and represent value for a buyer: location, client base, management team, vendor relationships, vertical focus and expertise, technical skill set, chemistry, etc. 

While some product-based companies were built to be acquired by a buyer identified in advance, this will most often not be the case for a services company. Instead, in the IT services space, many different fits are possible, resulting in broad consideration of potential transactions.

As we discussed in our previous column, myriad buyers (traditional and untraditional) are interested in the IT services space and generating transaction volume.

Global Factors: Finally, globalization continues to be a factor in the consolidation wave.

While offshoring of labor sources to India and China is nothing new, additional opportunities for offshoring are arising. Companies are looking to South America and Eastern Europe for new pools of lower-priced, but highly skilled, labor. Since offshoring practically requires a certain critical mass and high level of operational expertise, many opportunities exist for companies to build out offshoring opportunities that have been developed by smaller, entrepreneurial companies.

Juxtaposed with offshoring efforts has been the immigration of companies from outside the core United States market. We have seen a variety of inquiries from companies in Asia, Europe and the Americas looking to enter the U.S. by acquiring local delivery systems.

Overall, there is a perfect storm driving the IT services consolidation wave, and companies should prepare for opportunities that will undoubtedly be presented.

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 him on Twitter at MBSMergers.

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