Consolidation through the clouds

Adam Zoldan tells how businesses can take advantage of upcoming merger and acquisition activity

I believe we are on the verge of a new wave of investment in the channel and ensuing opportunities where firms could take advantage.

Despite the economic uncertainties forecast to continue into 2011, the year ahead is looking very interesting for the technology sector. Valuations are on the increase as both trade buyers and renewed interest from the private equity sector drive demand for acquisitions. A period of high activity is anticipated as the market consolidates, but channel SMBs may need to shift their focus to harness the investment opportunities.

This year we’ve seen a veritable spending spree of blockbuster acquisitions from corporates such as HP and Dell in the cloud and managed service space. This is now filtering through to UK based medium-sized businesses as they look to gain scale or branch into a complementary field.

Acquiring a company that has already established a strong customer base can be a more efficient way to achieve growth than doing so organically. It can also be a more efficient way to add expertise and expand cross-selling opportunities.

Mergers and acquisitions are also largely responsible for the advance of technological convergence, whether that be around voice and data, fixed and mobile technologies, or IT and telecommunications more generally.

While it is a prime time for SMBs to position themselves for acquisition or partnership deals, businesses that generate profit mainly from selling equipment and professional services will miss out on the valuation boom.

Stepping back a year, the industry weathered the recession relatively well -- but if we look at who suffered the most it was generally the businesses that had most exposure to big-ticket, high-value products. Capex slowed down, leasing dried up and companies such as Azurri, Redstone and 2e2 felt the pain with others that were going into administration.

This marked the start, in my opinion, of a major shift away from large one-off sales and towards hosted services.

We have advised on 21 completed deals in the channel in 21 months, most recently advising Spiritel on its £37m deal with the Daisy group.

We are seeing continued demand from trade buyers and huge interest from the private equity community. Recurring revenue is the key value driver every time --- while sales of equipment and professional services are heavily discounted as one-off items.

In an era where capital expenditure is being closely monitored, businesses need to consider ways to increase value as contracted managed services gain widespread acceptance. It’s all about customer ownership. And the perceived quality of earnings derived from a contracted customer that pays on a monthly or quarterly basis will deliver the highest valuations.

We are finding that managed hosting, connectivity and hosted applications are all high on buyers’ agendas as the industry moves further towards cloud-based offerings and services.

Resellers of kit – those who remain -- now need to decide whether to stick to being kit providers or move up the value chain and make a play in the SaaS or Platform as a Service (PaaS) spaces.

Interestingly, the telecom resellers that are seeing their voice revenues decline are making some real headway in SaaS. They already have the billing systems and back-office infrastructure in place, and adding an additional service to the customers’ solution is a relatively simple affair, especially with the high level of support they can receive from suppliers.

Telco valuations have been stuck at approximately six times Ebitda, whereas hosting and managed services businesses enjoy multiples of around 10 times Ebitda, The attraction is clear.

As with all new technological trends, the shift towards managed services is slowly becoming accepted by customers. A customer is unlikely to specifically request a cloud service but as the quality of connectivity improves, and the service levels that can be provided approach and in many circumstances exceed those offered by traditional customer premises equipment, even more customers will accept it.

In my opinion, there is a huge opportunity to build value and one that will pay rich dividends for those who choose to invest now.

Adam Zoldan is director at Knight Corporate Finance