IT Services M&A Slows, But Buyers Remain Hungry For MSPs And AI Solutions

‘My guess is that over the past few months, interest rates have been nudging up, and private equity funds rely on leverage, on debt, when they make acquisitions. A small move in interest rates can squeeze the private equity firms,’ says John Holland, managing director at Corporate Finance Associates.

M&A in the IT services industry slowed for a second consecutive quarter, but strong demand for MSPs and renewed activity from major strategic buyers show that the market remains resilient.

Deal volume declined 11 percent year over year before falling another eight percent from the second quarter, reflecting potential pressure from rising interest rates and tighter financing conditions, according to John Holland, managing director at Corporate Finance Associates.

Laguna Hills, Calif.-based Corporate Finance Associates is an investment banking firm with decades of experience in executing mergers and acquisitions in the IT and telecom services industries.

The slowdown, however, has not erased the uptick in deals made since before the pandemic. Holland believes the market is experiencing a natural fluctuation rather than the beginning of a downturn.

[Related: Behind The Curtain Of MSP M&A: Six Founders On Why They Sold]

“If you put it in perspective relative to before the pandemic, we still have considerably more M&A deals today than we did back in 2018 and 2019, so I’m not worried or concerned,” Holland told CRN. “My guess is that over the past few months, interest rates have been nudging up, and private equity funds rely on leverage, on debt, when they make acquisitions. A small move in interest rates can squeeze the private equity firms.”

Higher borrowing costs are also making buyers more cautious about where they deploy capital, leading some to take a wait-and-see approach to acquisitions. As a result, Holland doesn't expect M&A activity to rebound anytime soon, saying deal volume could remain flat or slip further before improving as interest rates come down.

“I think next year, as the Fed reduces interest rates, and whenever the inflationary pressures reduce, interest rates kind of descend gradually, then things will get back to normal,” he said.

Despite the decline in deal count, the total dollar value of public transactions remained relatively stable.

And AI is emerging as another potential driver as companies look to acquire AI talent and solutions, especially as solutions providers expand their offerings.

“I’ve talked with a number of business owners of AI solutions providers, and these companies are still small. They’re growing dramatically, but they’re still very small,” Holland said. “There’s demand, but there’s just not a supply of AI solutions providers out there to be acquired right now.”

And valuation expectations for AI businesses can lead to challenges. AI business owners often want buyers to account for future growth potential, while acquirers look at a company’s financial performance over the last 12 months. Holland said earnout agreements, which tie a portion of the purchase price to future performance, can help bridge that gap.

Meanwhile, MSPs remain among the industry’s most attractive acquisition targets, even as financing conditions change.

“The demand for MSPs has not diminished whatsoever. It’s still as strong as ever, and it’s because of their recurring revenue model,” he said. “It’s just so attractive for strategic buyers and for private equity firms.

“Strategic buyers are busy,” he added. “We talked about the slowdown, probably because of interest rates. Time will tell, but there’s still pretty healthy demand out there, and the MSP world is still consolidating very, very quickly.”

Kevin Damghani, founder and CEO of ITPartners+, a newer acquirer in the space, said MSPs with predictable recurring revenue and strong customer relationships remain attractive. But he’s always looking for new ways to drive growth and improve operations.

“AI introduces an entirely new dimension, allowing us to unlock efficiencies, accelerate growth and deliver capabilities that previously required significant headcount,” he told CRN.

He added that he believes the biggest winners in MSP M&A will be those who maximize the value of each deal.

“I believe the biggest winners won’t necessarily be those making the most acquisitions, but those creating the most value from each acquisition through AI,” he said.