Managed Services Acquisitions: Do Big Deals Threaten Small MSPs?

What a week for managed services mergers and acquisitions. Covad, Megapath and SpeakEasy are rolling up to form a national voice and data service provider. PC Mall is buying Network Services Plus Inc., a 73-person MSP. All Covered is dialing MSPs up and down the U.S. East Coast to see if they’d like to be acquired. And ETG, a health care MSP, is receiving unsolicited inquiries about its business. All this confirmed and potential M&A activity makes me wonder: Can small MSPs continue to go it alone?

First, let me provide some deeper details on each development:

1. Covad, Megapath and SpeakEasy: As you likely know, Covad and Megapath already are in the process of merging. The duo described their various IP offerings (including hosted VoIP) earlier this week to MSPs attending the Ingram Micro Cloud Summit (June 7, Dallas). Now, Covad is acquiring SpeakEasy, an ISP, from Best Buy. Covad says the deal creates “the first managed services local exchange carrier able to provide a full range of IP voice, security, VPN and Internet services nationwide,” according to Barrons.

2. PCMall and Network Services Plus Inc.: PC Mall‘s Sarcom Inc. subsidiary has acquired Network Services Plus, Inc. for roughly $7.8 million (the deal also includes potential long-term incentives for NSPI employees). NSPI, primarily a provider of hosted data center and managed IT services in the southeastern United States, had approximately 73 employees as of the closing date, 53 of whom are billable IT resources.

Now, some interesting stats:

• NSPI had unaudited revenues of approximately $6.4 million in the five months ended May 31, 2010, approximately 75% of which were service revenues.
• As of the closing date, NSPI has recurring revenue contracts generating in excess of $800,000 per month in revenue. That equates to about $9.6 million in annual recurring revenue, meaning that NSPI was valued at less than 1 times recurring revenues ($7.8M sale price divided by $9.6M annual recurring revenues). Please note: That’s a very rough estimate since I don’t have access to the potential bonus payout figures and other variables that potentially impact the deal’s overall value.

3. All Covered Makes More Inquiries: Several MSPs tell me they’ve received repeat phone calls and inquiries from All Covered, the solutions provider that been in M&A mode for more than a year. One recent deal involves All Covered buying The IT Pros, a managed services provider in Southern California. Some readers are quick to assert that All Covered is more of a IT consulting firm and reseller, but acquisitions could help All Covered to generate more and more recurring managed services revenues.

4. Calling for Health Care: Meanwhile, ETG — a managed services provider focused on health care — is receiving unsolicited M&A inquiries, according to CEO Mike Jones. But Jones has dismissed many of the calls, because the potential suitors were interested in geographic coverage rather than vertical market expertise.

5. Heightened Competition: Meanwhile, some MSPs tell me they are starting to experience heightened competition from mindSHIFT, which has leveraged a few M&A deals to pursue a national managed services strategy. In particular, mindSHIFT has been competing aggressively against smaller MSPs up and down the U.S.’s East Coast.

6. Global Trend: M&A activity isn’t limited to North America. MSPmentor has received inquiries from potential MSP suitors in Europe, the Middle East and Australia in recent weeks. (Our reply: Sorry, we don’t offer M&A guidance. We just spread the news… and pursue the rumors).

Exit Strategies?

Considering all the M&A activity and heightened competition, some readers may wonder: Is it time for small MSPs to sell out before they start to experience fierce competition from larger MSPs?

My personal opinion: There will always be a need — and a home — for smaller MSPs and even smaller VARs.

Of course, I’m extremely  biased (considering I’ve bet my career on the MSP and VAR media markets). In some cases, bigger is better. But in other cases, small, nimble businesses will always outperform lumbering giants.

Alas, the media often generates FUD (Fear, Uncertainty and Doubt) when big IT companies and consumer giants (Dell, HP, IBM, Best Buy, etc.) make services moves. But the services war has been raging for more than 15 years.

Note: If it’s so easy for corporate and consumer giants to conquer the IT industry:

• Why is Best Buy selling off SpeakEasy?
• Why is HP laying off 9,000 services professionals?
• Why is Dell, the recent buyer of Perot Systems, considering going private?

On the flipside: VARs and MSPs that evolved have thrived. Just ask Jones at ETG, where I suspect recurring revenues could double over the next year or so.

Here to Help

Still, there’s no sign of an M&A slowdown. And plenty of folks are seeking to match buyers and sellers, and/or assist with the process. A few examples:

• MSPAlliance Founder Charles Weaver has branched out in the M&A advisory industry with a consulting firm called Weaver & Associates.
• Three veterans of the managed services industry have launched Cogent Growth Partners to offer M&A guidance and post-sale integration services.
• Martin Wolf Securities has advised solutions providers on M&A activity since 1997.

Just be careful with all the M&A hype. Two or three deals a week adds up to about 150 deals a year. My best guess: There are more than 10,000 MSPs and 80,000 solutions providers in North America. If 150 of those companies decide to pursue M&A strategies this year, that’s not even one percent of the market…

My advice: Build your assets, build your brand and build your recurring revenue, etc. Succeed on your own and you’ll attract potential suitors without even trying. Then you can consider the offer from a position of strength.

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