What is fuelling the recent spate of M&A activity in the channel?

After the channel saw a spate of acquisitions last week, we investigate the significance of the timing and ask what spaces will see further consolidation

Last week saw a flurry of M&A activity in the channel, which has seen Network Utilities acquire rival Metropolitan Networks, private equity (PE) house Aliter Capital take Pinacl Solutions into its fold and Park Place Technologies purchase MCSA, among others.

Though the past 12 months have seen a lot of M&A and consolidation across all sectors of the channel, six acquisitions in the span of seven days is a rate of activity that would put Craig David to shame.

The flurry of activity seen in the past year has been partly driven by investment from PE houses, according to Neel Arampatta, senior analyst of infrastructure services at M&A watcher Megabuyte.

He said that the move from a lot of VARs from pure reselling into managed services has drawn great interest from PE houses, as they seek to invest in new areas.

"We are in a period of booming demand for IT products driven by digital transformation and people looking to technology to make their businesses more efficient," he explained.

"Resellers are now thinking about what happens when you're not in a boom - how do you continue to transact with customers who have a more squeezed budget? It's by offering more value-added services, which is a stickier proposition because you are locking them into a multi-year agreement.

"PE has traditionally stayed away from the channel part of the market because resellers don't have enough margin and it's low in terms of recurring revenue. But as these businesses move towards managed services, it means PE is becoming more interested."

Luke Kingston, a partner at PE house Horizon Capital (formerly Lyceum), agreed wholeheartedly with Arampatta's assessment.

He highlighted the fact that the growth levels seen by resellers offering managed services are an attractive lure for PE firms, as well as the fragmented market in which they operate.

"We are focusing our time here because we see high quality of earnings from the revenues of these businesses, good levels of organic growth, an ability to build business at scale, a robust business with diverse revenue streams," he said.

"When we bring a number of complementary businesses together they become greater than the sum of their parts."

One company that was acquired in the recent flurry of acquisitive activity is Welsh Internet of Things (IoT) specialist Pinacl Solutions.

CEO Rob Bardwell revealed that the company needed to meet funding requirements to go for bigger bids and sought out venture capitalists for the money. It came across Glasgow-based PE house Aliter Capital, which ended up buying the company.

Bardwell said that this was an example of how small VARs are trying to scale up in order to take advantage of the well of opportunities left behind by the collapse of large players.

"There's a number of SME-sized resellers that are looking to compete at the next level," he explained.

"The collapses of the bigger integrators like Carillion means there is an available mid-section - £20m to £50m opportunities - that a number of us resellers could go after if we had the wherewithal."

The final countdown

The frenzy of M&A activity at the end of last month coincided with what was the then mooted Brexit leave date of 29 March.

As we now know, that has been extended until 31 October, but did this have an impact on the six deals that were closed in the run-up to that deadline?

Bardwell admitted Brexit did play a part in when Pinacl inked its deal with Aliter.

"We were looking to get this deal done ahead of Brexit and I think that's why we've seen so many acquisitions happen in these last couple of weeks," he said.

"I think there has been paralysis with Brexit and some uncertainty around it in the venture capital community."

However, whether all the deals were accelerated ahead of the mooted leave date is a bone of contention for others.

UK software vendor Advanced has been on an M&A splurge itself over recent months, having acquired two companies since the start of the year - the most recent being Kirona - and is in the process of closing a deal in the next couple of weeks.

Andrew Hicks, CFO at Advanced, counters Bardwell's assessment stating that from what he has heard, Brexit has actually stemmed the flow on M&A activity.

"From our perspective, we've been tracking our three acquisitions for a while and the timing in which they've come together is the natural ebb and flow of the way deals happen sometimes," he explained.

"Without showing any political bias, I've heard of things being delayed because of Brexit rather than accelerated, but from our perspective, M&A is part of our strategy and we are looking to do more deals going forward."

Not all agree with Bardwell and Hick's assessments, however. Megabuyte's Arampatta stated that PE has been remarkably active in snapping up tech firms to add to their portfolios.

"I don't know if we can say that there has been paralysis in the channel," he said.

"But PE has been super active over the last four quarters. There may be some acceleration because of Brexit but I think they just need to spend that money and are looking at new areas to deploy that capital."

Horizon's Kingston added to this, stating that the threat of Brexit is not affecting PE's pockets for buying up tech firms.

"Brexit is the sword of Damocles hanging over everybody," he explained.

"But when the market really contracted back in 2008 and 2009 there was very little debt availability to corporates or to PE - there is not that liquidity issue now. In our business, we are not expecting to see a slowdown in deal activity."

Place your bets

Last year saw a huge amount of M&A activity in the cybersecurity space. The managed print sector also witnessed the massive HP takeover of its partner Apogee, and the licensing world saw the gargantuan merger of SoftwareONE and Comparex.

The momentum seen in the past couple of weeks will continue throughout this year, according to those we spoke with. But what space are they predicting will see the most activity?

Analyst Arampatta suggested a number of "fruitful areas of consolidation", including business comms, managed print services, networking and security and cybersecurity assurance.

"The MCSA acquisition is a big one and I think the OCSL takeover by Cancom was in that same league last year," he said.

"What I think may drive that activity in 2019 is smaller businesses getting to a certain stage and hitting a plateau and looking at PE or a larger trade buyer to help them get to the next stage."

He has also observed a trend among the channel of investing in Microsoft specialisation and certification, which he predicts will be a growing area of interest.

"MCSA is a good example of this," he noted.

"It's a business that historically has been an HPE shop; they won their Microsoft Gold Datacentre Partner award earlier this year and it's now front and centre of their marketing.

"Probably 80 per cent OCSL's revenue is HPE tin, but all they talk about in their marketing material is Microsoft. I think people will jump on the bandwagon to get some credentials."

Pinacl CEO Bardwell foresees consolidation among companies that specialise in emerging technologies.

"The technologies around IoT and artificial intelligence are starting to form a subset of resellers who are focused on smart types of environments and that is driving M&A in terms of like-minded companies coming together," he added.

PE will continue to dive into the channel, snapping up technology companies, according to Horizon's Kingston, who said that his firm will continue to focus on companies that specialise in intellectual property, data, software and business services.

The longevity of this M&A is not in doubt, as it is a core element in certain sectors of the channel, according to Arampatta.

"There's always going to be some markets where acquisitions are going to be part and parcel - for example, managed print because that is a low organic growth market and revenue is driven through acquisition," he explained.

"There's a lot of scope for debt-funded or PE-funded consolidation in all parts of the VAR market, whether it be managed print, generalist cloud services, or wherever.

"There are so many players in each of those markets at different levels of development, there is plenty of scope from bigger guys who have a war chest behind them."