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Is closing an M&A in the channel right now realistic?

Julian Box outlines what the right conditions are to close a deal as coronavirus continues to haunt the marketplace

Mergers and acquisitions

Managed Service Providers (MSPs) haven’t ever felt pressure quite like they have over the last four months, and while some businesses are beginning to emerge from the other side of lockdown unscathed, it’s evident many others are still feeling a significant amount strain being passed down the chain.

Customers are challenging service providers to support them through the most tumultuous market conditions of a generation, all while trying to save as much capital in the process. For many MSPs, this translates to trying to rapidly improve their own productivity and efficiency as well as their customers’, and not surprisingly, many have struggled. 

This has led to an MSP market of extremes, with high-performing firms and strugglers at polar ends of the spectrum, leaving those in the middle with difficult decisions to make to overcome a punishing economy and return to pre-pandemic conditions. This significant shift, however, has created the perfect storm for M&A activity as buyers look to capitalise on either those that have proven the value of their business models or to seize the opportunity of rescuing under-achievers.

The resilience of IT and data services 

In addition to unprecedented market conditions, overall interest in the MSP space from private equity investors is greater than it has been for a long time. These firms still need to make investments, and IT and data services have been singled out as being rare examples of businesses that could succeed during crises or other economic downturns such as COVID-19. This is due to businesses’ unavoidable reliance on safe, accessible data regardless of market conditions. 

Now is a pivotal time for MSPs to prove to potential investors how adaptable they can be, and how resilient and well-conceived their business model truly is. It’s a prime opportunity for innovative firms to be recognised for how their services, and the way they deliver them, differs from other providers, and how much appetite there is for their offerings. With expectations during the pandemic being so high, however, the divide between those who meet customer expectations and those who do not - or cannot - are only exacerbated.

No company wants to be bought because they fall into the “rescue” bracket, of course, and businesses need to be able to effectively showcase their ability to react to the turbulent market conditions to inspire faith among potential investors. 

COVID-19 represents additional pressures

There’s already a high proportion of MSPs that have been unsuccessful in impressing investors as the pandemic continues to disrupt their business models, calling into question their overall resilience. Of course, some investors will believe a company’s performance can be turned around by injecting capital and renewing the strategy, but it won’t always be the case.

Calligo, for example, recently pulled out of a potential acquisition for exactly this reason. There were some initial warning signs linked to standard metrics, such as high running costs and sub-par 2019 growth. Though it was when we looked at the target business’ uninspiring commercial response to the pandemic that the most doubt was cast on claims around future growth. The company’s performance just couldn’t bear the additional scrutiny that COVID-19 represented.

By contrast, we were lucky enough in our recent acquisition of Ireland-based Itomic Voice and Data to have been conducting initial discussions with the company pre-pandemic. Some minor unrelated delays in the process meant that we were then able to use the crisis as a testbed for the business’ resilience and commercial response. This allowed us to fully vet the business during a period of tremendous difficulty. Needless to say, they met our expectations until the acquisition closed in June.

Green-lighting your next move

Our experience shows that acquirers are placing a premium on agility and commercial savviness during this crisis, in addition to valuing a business with a deep understanding of their customers’ needs. This applies not only in terms of reacting to financial constraints or how their operations changed how they required support but also in terms of how they delivered and proved additional value to their customers. 

Cloud service and connectivity goes so far, for example, but firms looking to make acquisitions are also looking for whether customers can be helped to make the best use of data. This may manifest in an MSP offering collaboration services, or even helping processes become more productive by offering automation. This is the sort of broader proposition that excites buyers as the MSP is closer to the customer needs, and the overall package is based on value not price. 

MSPs looking to acquire new firms over the coming months should first consider the breadth of the value the target acquisition brings to its customers and whether these customers simply buy from them - or rely on them. Beyond that, the question of COVID-19 rears its head. Businesses should examine how the target performed during the crisis, and what evidence there may be of successful agility and reaction to clients’ needs. Finally, businesses should assess any target’s portfolio and judge whether it’s well-positioned to meet the challenges of any future coronavirus turbulence. The first few months post-acquisition are when performance is most important and expectations simply must be met. 

Julian Box is the founder and CEO of Calligo

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