The Takeaway: A Q&A With Malte Abrams on the Drivers of Consolidation in the IT Services Sector
Why is the IT services sector still comparatively fragmented and when did consolidation pick up speed?
The sector is highly fragmented, with many IT companies founded 10 to 20 years ago, when digitization was just beginning, and many highly specialized smaller companies, which were founded quite recently.
Now, the consolidation we are seeing is driven by succession and the need for either size or specialization in new digital technologies such as data and analytics, blockchain, cybersecurity, the cloud, and the Internet of Things. On top of this, we face a difficult labor market with scarcity of talent.
Overall, we see varying levels of consolidation from region to region. Across markets in Europe, the DACH region is several years behind the Nordic and Benelux regions.
What are the key drivers of this consolidation?
In today’s markets, companies need scale to be competitive. We see four key drivers:
- Market consolidation: M&A was often used as a strategy for consolidation within the IT sector. Larger companies acquired smaller firms to expand their market share, customer base, and product/service portfolios. This resulted in a more streamlined and competitive landscape.
- Technology advancement: This includes rapid technological developments, such as AI, cloud computing, cybersecurity, and data analytics. Specialization and exposure to emerging technologies has a positive effect on performance and valuation.
- Demand for "end-to-end" offerings: Companies are looking for support ranging from consulting and implementation/software development to managed services.
- Talent shortage: A powerful branding for recruiting, training, and incentives is important to attract and retain talent.
The deal’s strategic rationale and level of integration of buy-and-build strategies are now important for investors because post-merger integration also entails many risks. Does the culture fit? Can I retain talent? Also, we look at whether cross-selling is possible so that the company’s offerings can potentially be combined.
How does this affect M&A activity and what do you expect to happen to valuations?
In the past 12 to 18 months, private equity firms have been the main drivers in a low interest rate and significant add-on potential environment. However, in the current market, next to private equity firms, we are observing strategic buyers who are returning to acquire specialized companies to fill a gap in their offering or geographic market footprint.
In terms of valuations, we see consistently strong valuations and expect this to continue. Generally, multiples in the IT services space have increased significantly compared to five to 10 years ago, driven by accelerated digitization and reoccurring revenues.
Is it a seller’s market?
It depends on the specifics of each company: Currently, we observe strong growth of providers focusing on enterprise clients as opposed to mid-market customers. Some consulting and system integrations are postponed, but in general, it is a good time to sell. We are in the middle of a consolidation wave; there are many acquisitions of specialized companies, and therefore, it is important to precisely define your own position in the dynamic market.
What will the market look like five years down the line?
Private equity will continue to drive the market because they can easily expand the company's portfolio and benefit from multiple arbitrages, internationalization and upselling. There is also a lot of strategic interest in data analytics, custom software development, public cloud, and cybersecurity. I expect that at the end of consolidation, about 20 to 30 companies with 10,000 to 20,000 employees and a few large companies with a million employees or more, will make up the market—in addition to the continued presence of many small providers.
