Amid the “everything as a service” hype, thousands of MSPs and VARs are exploring ways to shift their hardware sales from CapEx to OpEx business models. You know the conventional wisdom: Monthly recurring revenue — rather than one-time product sales — provides a more predictable business model and typically lifts business valuations along the way.
With that thesis in mind, many MSPs are exploring hardware as a service (HaaS), device as a service (DaaS) and other pay-as-you-go hardware models for end-customers. After several false starts a decade ago, HaaS and DaaS now have traction in some market segments.
Why I Care: I take Evergreen’s M&A and valuation viewpoints seriously because the team has skin in the game. They’ve spent thousands of hours speaking with more than 700 MSPs about potential M&A deals, and the company has actually opened its wallet multiple times to consummate MSP buyouts across the country.
HaaS – Read the Fine Print: Before you read on, it’s important to keep the Q&A interview below in context. HaaS and DaaS come in many forms. In some cases, the MSP takes ownership of the hardware. In other cases, the MSP never actually owns the HaaS equipment. MSP valuations can vary greatly based on which model and partner engagements you pursue. Also, MSP buyers (private equity firms, peer MSPs, strategic investors, etc.) use various models to estimate and set valuations. Evergreen’s own Valuation Worksheet may vary significantly from other buyer models and considerations.
The Background: The seeds for this interview were planted during two separate conferences. I caught up with the Evergreen Services Group team during a trip to RSA Conference 2019 in March. We stumbled onto the HaaS-MSP valuation topic during that meeting. I was intrigued. Then I got distracted. Then Evergreen Services Group and I regrouped at this week’s Kaseya Connect IT Global 2019 conference in Las Vegas.
Ramsey Sahyoun, head of M&A at Evergreen Services Group, and I quickly dove into the valuation discussion during an impromptu “How the heck are you?” conversation in the hallway on May 7. Ramsey is a details guy. I’m a sound bite guy. Something was bound to get lost in translation (by me) in that hallway. After a brief face-to-face catchup, email became the perfect method to capture Ramsey’s deeper thoughts in detail on May 8. Here’s the interview.
ChannelE2E: What impact does HaaS have on MSP valuations? Is there a downside?
Sahyoun: In our view, HaaS has a VERY negative impact on MSP valuations because of the capital expenditures (typically called Capex) required to use that business model. Capex is a real cash expense that we factor into our valuation on every acquisition we’ve made. MSPs that don’t do HaaS or private cloud typically have very little in the way of Capex (that’s one of the reasons we like MSPs!), so EBITDA generally approximates cash flow. With HaaS or private cloud businesses, there is so much Capex that cash flow is significantly lower than EBITDA. And that impacts valuation very negatively because we apply our multiple to cash flow.
We’ve now had conversations with over 700 MSP business owners and one of the unfortunate things I see is that they adopt HaaS because it makes their EBITDA look better. They compare their EBITDA margins to their peers and it makes them feel like they’re doing great, but they actually end up generating less cash flow. It’s unfortunate because it has a negative impact on both the cash that an owner gets from his/her business every year and also on the ultimate valuation.
The only saving grace about HaaS is that it turns hardware into a recurring revenue stream, so it will improve a company’s revenue mix. For example, our threshold for recurring revenue is 50%, so sometimes HaaS can help an MSP get into a recurring revenue % that will appeal to buyers. But overall, we’d much rather see managed services revenue itself be 50%+ of the total and we won’t value HaaS revenue as highly as managed services.
ChannelE2E: Should MSPs instead focus on leasing and other types of financing to keep hardware off their books?
Sahyoun: If I was an MSP business owner I wouldn’t worry about using tricks to get the hardware revenue off the books. I would instead focus time and energy on growing managed services to be a greater and greater portion of total revenue to where hardware doesn’t impact bottom line profitability as much.
I would encourage folks to try to get favorable arrangements with vendors/distributors. It can be challenging for MSPs from a cash flow perspective to pay for hardware upfront and resell it, and we’ve seen some companies have favorable arrangements where they just get a commission from the distributor instead of carrying inventory.
ChannelE2E: What impact does private cloud/building-owning data centers have on MSP valuations?
Sahyoun: Similar to HaaS, the capex associated with private cloud and data centers have a negative impact on valuations. Most MSPs I’ve talked to that invested in building their own data center try to use it as a differentiator to the end customer, but they almost always tell me they wouldn’t make the investment knowing what they know today.
Competition from public cloud is intense. AWS and Azure cut prices regularly and have better functionality in most cases, so it’s a very tough business.
While the margins on private cloud are higher, the difference isn’t has great as most people think when you factor in the capex associated with private cloud whereas public cloud requires literally zero capex.
Overall, I would say private cloud is a negative on valuations, but different people have different perspectives. The one major takeaway from all of this is that people need to consider capex as the real expense that it is when they’re considering what paths to take in building their business.
What’s Your View?
Got a differing opinion for me? My email inbox awaits your view. And yes, comments below are welcome. -Joe Panettieri, Content Czar, ChannelE2E
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