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Five Reasons Private Equity Firms Pursue MSP Buyouts, Investments

David Del Papa

Why are Private Equity firms so interested in MSP investments and acquisitions? The answer involves five key market dynamics, according to David Del Papa of Riverside Partners.

During an MSP M&A Symposium to kick off the Kaseya Connect 2018 conference in Las Vegas, Del Papa pointed to:

1. The increasing amount of capital that private equity firms have to invest.

2. The mission critical, recurring revenue nature of MSP services. In other words, the market isn’t a passing fad.

3. The significant MSP industry tailwinds. Businesses of all sizes are spending more on IT during multiple inflection points (cloud, greater outsourcing of non-core functions, digital transformation, etc.). That bodes well for MSP investments, he says.

4. Evolving MSP business model enables greater scalability and margins. In other words, there’s real scale and less dependence on hardware sales and labor.

5. The highly fragmented MSP market provides numerous acquisition opportunities and potential benefits from M&A.

Reality Check

I certainly agree with Del Papa’s points. But I also worry about a few of them. First and foremost, I’m concerned about point one: Private Equity firms are loaded with cash that they want to invest. And in reality, they need to invest the money. They need to put it to work. That pressure to spend, in my opinion, could trigger some bad deals.

Or as I put it: Private Equity may be chasing MSPs on a short runway

I also worry about point five — the MSP market is highly fragmented. That’s true. But the heavy fragmentation involves lots of less-than-stellar resellers and VARs that aren’t true MSPs. And many of those true MSPs deliver less-than-stellar profit margins (9 percent or below).

My constructive criticism isn’t specifically directed at Del Papa. He’s a sharp guy. And certainly, each PE firm is conducting extensive, intensive due diligence before inking an MSP investment or buyout. In Del Papa’s case, he’s looking closely at margins, recurring revenue percentages, churn, and other factors that separate quality MSPs from the pretenders.

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7 Comments

Comments

    Todd Hussey:

    Joe,

    I agree. I always shake my head a bit when a VC et al say “well we have lots of $ to spend” – yikes, year 2000 again!! I’m also willing to bet “their eyes are wide open now”, but when they look real closely they’ll find there aren’t nearly as many quality deals out there for them.

    DLo59:

    So private equity is interested in MSPs but typical PE groups are looking for a grand exit themselves. Who are they going to sell to? A larger MSP? A vendor? Would they hold the investment and be happy with x% return? What’s the end game?

    Todd L Hussey:

    Great question on “what’s the end game”. I have no idea. If what Jay McBain states (the following) then there is no end game. – It’s do-or-die time for smaller businesses and value-added resellers.
    Verdict: We saw some startling statistics surface in 2018; the most shocking was that 70% of MSPs are looking for an exit. With average margins falling to 17% and 96% of MSPs unable to scale past 10 people, the traditional channel is bifurcating. The have-nots will continue to struggle in 2019, and many vendors will spend futile dollars trying to get them to cross the chasm.

    Joe Panettieri:

    I have similar concerns about how all these MSP buyouts will play out. But I do think some of the stats are misleading.

    1. First, 70 percent of MSPs are NOT looking for an exit. Rather, 70 percent of MSPs in a small sample said they are interested in an exit. As the old saying goes: Everything is for sale — at the right price. That’s far different than actively seeking an exit.

    2. It’s not accurate to say that 96 percent of MSPs are “unable” to scale past 10 people. Many of those MSPs simply don’t want to scale past 10 people. They’re happy running small, lifestyle businesses. I’m not suggesting that’s a safe strategy. But as long as those small MSPs continue to evolve their services, they may actually be smarter than “scale at all costs” MSPs that haven’t really managed their profitability.

    3. Real risks: Challenges ahead, no doubt. PE firms, in some cases, are lowering their standards to buy lesser-quality MSPs. That could prove dangerous long-term.

    But be careful of the market stats. I think they’re often misleading.

    PS: We’ll announce the Top 100 MSP mergers & acquisitions as part of our January 24, 2019 webcast. http://www.channele2e.com/webcasts.
    -jp

    Todd L Hussey:

    Joe, 1st let’s get off calling all ITSPs as MSPs – they are not – MAYBE 10-20% of all ITSPs are MSPs. 2nd, in the past 12 or so months a HUGE % of ITSPs (including MSPs) I speak with are slowly (quickly??) getting killed by “low cost of entry trunk slammers and shadow channels and cloud CSPs”. And these guys are seeing their valuations evaporate. And their “so-called” life style business of 10 people will be forced to become a life style of 9 people, then 8, then 7 etc. Net:net, if these ITSPs don’t embrace cloud, find a nice niche and specialize with services – they’re toast – “it is what it is”.

    DLo59:

    “Net:net, if these ITSPs don’t embrace cloud, find a nice niche and specialize with services – they’re toast – “it is what it is””

    This race to the bottom will shake out the lifestyle businesses and force MSPs/ITSPs to evolve (or die)…just like the evolution their customer is undergoing in the move to the cloud. (With exceptions of course).

    Additionally, according to an MSP conference I attended, the move to the cloud is going to grow the industry by 72% over the next 4 years and MRR appears to be much more lucrative than the traditional margin based business model and Wall Street loves the MRR business model. That’s all good for well run MSP/ITSP businesses.

    And yet, I’m puzzled. Why would are PE firms taking perfectly good capital and investing it in businesses in which they don’t own the IP, products, rights to the customer or have any guarantee that their vendor relationship will continue beyond their current distribution agreement term (typically a year I imagine). I can think of better ways to invest the money…

    There has to be something else happening, there has to be a subsequent “play” for the PE firms in the future – otherwise, they’re just in the MSP/ITSP/VAR business. (Maybe that’s it…maybe they’re banking on major growth over the next 4-5 years and are happy with the ROI).

    Joe Panettieri:

    Q: Why are PE firms investing in MSPs that don’t have IP?

    A: Because SaaS companies are often too expensive to acquire. MSPs are a close cousin with recurring revenue at a lower multiple in a very highly fragmented market. I certainly believe well-run MSPs that grow responsibly and generate healthy EBIDTA warrant the investments. But PE firms are having trouble finding those high-quality targets.
    -jp

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