Activity in the telco M&A market remains buoyant with a noticeable trend emerging during the past few months, observes Paul Russell, Corporate Finance Partner for M&A at BDO.
In the second and third quarters of 2016 telecoms M&A saw previously struggling assets changing hands and according to Russell this development is a notable trend. "We attribute this to ambitious management teams seeking to grow by acquisition, rather than due to any sign of distress in the sector," he said. "The obvious deals being Maintel's £48.5 million acquisition of Azzurri and GCI taking over Outsourcery's assets."
Meanwhile, noted Russell, the sector continues to attract private equity interest with Livingbridge and FPE investing in Southern Communications and Optimity respectively. "Fund raising activity has also been strong, including Maintel's £24 million to part fund the Azzurri deal and Gigaclear's £24 million for its rural broadband roll out," he added.
The appetite for M&A has not, perhaps surprisingly, waned post-Brexit. "It has largely been business as usual," said Russell. "The market fundamentals remain strong. We estimate that only 10 per cent of M&A transactions have been lost due to Brexit. The vast majority of deals have not been falling over and new business M&A activity is at good levels."
This positive outlook is underpinned by £50 billion of dry powder in the private equity space. "We anticipate that PE houses will keep spending as evidenced by the recent Southern Communications (Livingbridge), Sabin (Lyceum) and IT Labs (ECI) deals," added Russell.
Numerous international and UK trade buyers are also actively looking to acquire and debt markets remain open. "We see overseas bidders spotting an opportunity in the UK with the fall in sterling outweighing the risks of Brexit uncertainty," noted Russell. "In particular, US private equity money is coming into the market which perhaps is not surprising given the pound's three decade low against the dollar. The acquisition of Lyceum backed managed services company Adapt by US PE house Abry backed Datapipe could be an early example of this."
The drivers of M&A activity will remain as they have been over the last few years, believes Russell. These are firstly a chance to diversify into new areas that can provide future growth. Alternative Networks' acquisition of Control Circle and Pulsant's acquisition of Onyx are good examples of this. Secondly, companies will continue to acquire bases or similar companies to provide organic growth, which is sometimes hard to generate across the industry. "What will probably emerge as a trend post the current deal flurry is an increased appetite for bolt-on companies to propel top line and EBITDA growth," said Russell.
Despite some previous high profile company plans not working out as expected such as Outsourcery and Azzurri, there is a healthy appetite among existing and new investors in the wider tech and telco space. "ECI, Lyceum and Livingbridge have all had previous experience in the space and invested in the last quarter in new deals," added Russell. "All of these plans will probably assume inorganic and organic growth and a desire to get to the magic £100 million turnover, circa £10 million EBITDA level."
There are two pricing models at play. Established, larger and growing companies such as Sabio and Southern Communications attract high valuations that are close to or at double digit multiples. However, this will not translate to a smaller base or company that is, for example, lower margin with single/few customer dependency, where the multiples will be much lower. "What is interesting is that I expect a bidding war to ensue for the right assets from the companies that all have new funding, and hence the prices of the smaller players may inflate," said Russell.
Clearly, there are some big shifts in the market at the top level with BT/EE, but the mid-market is also going through a change with companies that have been privately owned taking on investment for the first time, and companies that have been through their first PE cycle finding new homes such as Selection Services, Adapt and Onyx. "This means the lower mid-market gets consolidated, the players become bigger and the fight for juicy bolt-ons intensifies," noted Russell.
In terms of acquirers pursuing a diverse approach to the evolving market, with M&A in the area of new business segments (such as M2M) as a means to strengthen overall digital offerings, Russell expects to see this trend continuing with broad based players acquiring specialist companies to add further services to their offerings, and ideally cross sell across the existing base. "Clarinet's acquisition of the gaming specialist Ardenta is a great example," he said. "This type of acquisition both locks in customers through the specialist services and protect margins."
In such a buoyant M&A environment Russell expects the market to refresh itself. "The current generation of mid-market businesses that are being transacted came about as talented individuals left big companies to establish nimble start-ups," he explained. "As the market consolidates quickly I believe this will happen again, so in five years time the mid-market companies that we are talking about may not then exist.
"Deal activity in recent years has been driven by the convergence of voice and data and the battle to deliver UC. As both of these have been achieved from a technological viewpoint, we wonder what future technology and innovation will enable companies to outpace their peers."•