During the pandemic technology, media and telecommunications (TMT) companies played a crucial role in providing the tools and solutions that enabled connectivity, collaboration and communication. Their collective stock rose as they enabled productivity within remote working teams whilst the fortunes of traditional businesses plummeted.
Post-pandemic businesses in the TMT sector are now bracing themselves for the effects of new and different market forces as the effects of the war in Ukraine, rising prices, high interest and supply chain issues are all stoking the fires of recession.
At a recent panel discussion hosted at the Reform Club in London’s Piccadilly, four industry experts took time to pause and reflect on how these new conditions are accelerating the need for TMT businesses to change their focus to build business value.
The post-Covid market
The pandemic had a seismic effect on many businesses, a lot of it bad but some of it good. Two years of Covid-19 saw a 50 per cent increase in the valuations of technology portfolios translating into a 30 per cent uplift in the value of NASDAQ’s IT stocks. During this period investors saw technology as a safe haven and a good fit for market conditions and they reacted accordingly.
In the UK mid-market TMT sector quality of earnings remained high, reinforced by sound fundamentals including healthy monthly recurring revenues. In short, the organisations that were already providing pandemic-friendly solutions were pushing against an open door.
Since lockdown conditions were lifted there has been something of a reversal of fortunes as traditional industries have made a comeback. However, acquisition activity in TMT continues unabated particularly in focused areas like cybersecurity and infrastructure services.
50 per cent of the deals on which we advised were SaaS-based software companies and we don’t see that trend changing much in the M&A space. Whatever the market conditions, quality of earnings is probably the key buying criterion.
Driving deals
For investors looking to invest in the TMT market resilience is the key as valuations “cool off”. There appears to be a wholesale return to fundamentals since the departure of the Covid years with demonstrable ROI and strong EBITDA performance taking centre stage. In terms of the M&A market, there is still a lot of activity, although not quite at the level experienced during the pandemic.
Valuations are more often than not based on cash revenues today rather than the huge potential of recurring MRRs tomorrow. The drivers for valuations now need to factor in high-interest rates and low growth rates but the players in this space are highly resilient and have learned to thrive in adverse market conditions.
“What might have generated value yesterday is completely different to current perceptions. Cash revenues today versus recurring revenues tomorrow present a very different picture in a post-pandemic world,” explained Barney Taylor, CEO, Focus Group.
Profitability is the key element to a realistic valuation in today’s climate and while there has been a post-pandemic adjustment in seller aspirations the rising cost of people, increased cash burn and heavy debt will inevitably have a knock-on effect.
During the pandemic, valuations were generally guided by EBITDA multiples, for example, a standard telco provider (multiple 6-7), hybrid cloud provider (multiple 15-18), and A.I./Cybersecurity (multiple 20+).
However, in the current climate quality of earnings, cash generation, the strength of recurring revenues and, most importantly, profitability are the core KPIs that determine a successful valuation. A company with predictable and stable revenues has already put in place vital fundamental building blocks.
Add into the mix current blockages in the supply chain and it is easy to see how increased costs and delayed deliveries are going to affect profitability.
For example, Ukraine supplies a huge proportion of the world’s semiconductor-grade neon, a gas integral to the lasers used in the chipmaking process, while Russia supplies most of the palladium supply, a rare metal that can be used to create semiconductors.
The resultant delays of the basic components are starting to have a massive effect on the profitability of all companies dependent on these resources.
The opportunities
In terms of the opportunities for an MSP in a post-Covid world, adversity presents an opportunity for many entrepreneurial businesses and the post-pandemic environment offers numerous possibilities.
For many mid-market organisations, the pandemic levelled the playing field and actually accelerated planning to provide more services and solutions to customers. Voice and data are no longer clear differentiators for the mid-market Telco suppliers.
Businesses need to be able to provide a greater variety of services and bundles of software to include say, cyber security or public cloud management tooling. Post-pandemic, customers with trusted supplier relationships will nearly always buy from the same companies.
Chris Morgan, an investor at BGF, explained, “The opportunity exists for smaller providers to take away business from their larger rivals by increasing their delivery capabilities. With good account management, an MSP can leverage trusted customer partnerships and become a one-stop shop.”
Deal making
Despite the turmoil induced during and post-Covid, there is a considerable appetite in a buoyant M&A market with lots of private equity activity and buyer interest.
Owners’ appetites have changed a little but the drive to plan ahead and attempt to be more selective has provided a marked change.
Early engagement with expert advisors has been a step change and most sellers have wisely jettisoned the ‘DIY’ approach when making a business disposal.
Furthermore, there is evidence of considerable consolidation in the market with the plenty of associated activity. Potential buyers are now considering a number of different factors as well as the obvious financial ones.
Talent retention is high on the list which is also seen as the biggest risk to steady growth. Potential sellers have to work considerably harder at not only attracting but also retaining key members of staff.
Other factors include diversity, culture change and moving to net zero – whilst avoiding greenwashing. ESG (Environmental, Social and Governance) is becoming another key factor in determining non-financial company value in the post-Covid climate and can be a critical factor for establishing operational value.
With Brexit adding to the problem of labour shortage it is now more important than ever to retain key staff to help deliver the company’s vision.
Ian Mason, corporate director, TMT, RBS Group, said, “There is a new generation of employees out there asking different questions of their employer. Is there a well-being scheme? Can I buy an electric vehicle through the company? Is there a ‘ride to work’ scheme?
“These are all questions that a modern business has to think about and find workable solutions if they’re to attract and retain the best people.”
Real value
Hopefully the Covid crisis is passed but, in its aftermath, mid-market TMT companies need to be agile when evolving their propositions and operating models to build value. Solving this “final bend” challenge requires resilience, integrated business processes and agile change management.
Real value can ultimately be delivered only by increasing the quality of earnings and increasing bottom line profitability.
Comms Business interviewed Nigel Cook last year. Read more here.