MSP Consolidation: Private Equity's Next Move

The Promising Trajectory of Managed Services Providers

The future appears bright for managed services providers (MSPs), as escalating complexity and heightened security risks – spurred by remote work trends and prominent cyberattacks – have redefined IT management. It has transitioned from a mere cost center to a vital strategic priority for executive leadership.

The Growing Demand for Specialized IT Expertise

A significant factor driving the expansion of MSPs is the scarcity of skilled professionals needed to effectively manage and safeguard intricate IT infrastructures. This shortage makes it challenging for numerous organizations to cultivate and sustain internal IT teams capable of meeting these demands.

Consequently, an increasing number of businesses are opting to outsource their IT management, either partially or entirely, to highly qualified managed service providers. Industry analysts suggest that the managed services market is only 30%-40% saturated, indicating substantial potential for growth and expansion for MSPs.

Private Equity Investment and Industry Consolidation

Private equity investors have recognized these favorable conditions and are actively seeking opportunities to invest in the sector. This influx of capital is expected to accelerate the ongoing consolidation trend within the MSP landscape.

MSPs possess characteristics highly attractive to private equity firms – consistent demand, minimal risk of becoming obsolete, a service that fosters customer loyalty, substantial recurring revenue, robust cash flow, and a relatively asset-light operational model. Furthermore, the industry’s fragmented nature, with approximately 40,000 MSPs in the U.S. (as of 2019), presents ample opportunities for private equity firms to create larger entities through strategic acquisitions.

Currently, numerous private equity firms have already invested in the sector. Cowen reports tracking around 50 private equity-owned MSPs, many of which have already engaged in multiple acquisitions.

Acquisition Trends and Firm Growth

The current wave of consolidation often involves acquiring MSPs with Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) ranging from $3 million to $10 million. These firms are then expanded organically and through additional acquisitions. However, larger private equity firms are now entering the market to establish significant regional or specialized MSPs.

Recent examples of larger private equity firms acquiring MSPs initially built by smaller firms include:

• Thrive, initially partnered with M/C Partners ($350 million fund), underwent a recapitalization with Court Square Capital ($2.7 billion fund).

• VC3, originally with WestView Capital Partners ($700 million fund), was sold to Nautic Partners ($1.5 billion fund).

• New Era Technologies, initially partnered with Gemini Investors ($64 million fund), completed a recapitalization with Sentinel Capital Partners ($2.2 billion fund).

• InterVision, initially partnered with Huron Capital Partners ($550 million fund), completed a recapitalization transaction with MidOcean Partners ($1.2 billion fund).

Valuation and Key Performance Indicators

Despite the intense interest and robust M&A activity, MSPs cannot simply rely on market enthusiasm to secure premium valuations. Private equity firms prioritize companies demonstrating rapid growth, strong profitability, a capable management team, and, critically, a substantial proportion of recurring revenue – with 75% increasingly becoming the standard for leading MSPs.

MSPs with specialized expertise in high-demand areas like cloud services and security are particularly desirable. Those meeting these criteria can achieve valuations exceeding 10 times trailing EBITDA, with industry leaders commanding multiples in the mid-teens or higher.

The Future of MSP Acquisitions

While consolidation will eventually lead to a decrease in acquisition demand, we are not at that point yet. Recent sales processes have attracted 30-40 private equity bidders, facing competition from value-added resellers, systems integrators, IT consultants, telecom firms, hosting companies, and infrastructure providers.

Therefore, the current environment presents a favorable opportunity for MSP owners to realize a return on their investment. Those focused on growth and capitalizing on post-pandemic trends must continuously innovate in cloud and security services and prepare for increased competition in the coming years.