M&A Industry Insights: Information Technology

M&A Industry Insights: Information Technology

In the past year, technology has become more important than ever, forcing new approaches to regular activities from doctor visits to working from home. The industry has seen record M&A Activity and has outperformed almost all other industries for the last decade. Most of the growth in the public markets has been dominated by household FAANG stocks; technology sector stocks have grown at a CAGR of 17.6% over the last decade, with tremendous price growth of 43.4% in the last year alone. 

2020 saw Alphabet Inc. join the elusive trillion-dollar club as entertainment consumption on platforms like YouTube surged. The increased free time afforded to consumers who no longer have to commute increased streaming service revenues by 20.1% across North America.

SaaS During COVID-19

 

 

Software as a service (SaaS) refers to the distribution of a collection of software that effectively links content between different programs, devices, and users, through a third-party host. Internet connectivity and basic computational hardware are the only requirements from the client, with the service provider responsible for meeting all other requirements. The industry has seen a surge in M&A activity and consolidation as larger Software consolidators continue to vertically integrate.

Currently dominated by Salesforce and Microsoft’s Azure, several firms have introduced SaaS lines but struggle to compete with the hallmarks’ selection of software. With other subsectors separated, SaaS sales fell 0.6% in 2020 but are expected to recover with growth rates of 16.1% and 17.4% in 2021 and 2022 respectively. We see a continued trend towards increased market concentration in this space.

 

Remote desktops solve problems of compatibility as some of these workers would be specialized in a particular program that may not have close substitutes provided in SaaS packages. This subsector is expected to continue growing at 61.5% but shrinking its growth to match its peers with YoY revenue expansion of 30.7% in 2022 (Gartner). This subsector is relatively hardware intensive as the only constraint to expansion is server space. We see concentration levels remain relatively low in this sector as the high market cap firms focus on providing their established software suites over commoditizing their server houses.

Alternative service models such as PaaS (platforms as a service) and IaaS (infrastructure as a service) show similar growth patterns but represent a smaller segment of the overall cloud business model. These segments also experienced reduced growth in 2020 but are expected to return to rates of around 27% in 2021. 

Growth in DaaS Sub-Sector

Desktops as a service (DaaS), a sub-sector that experienced revenue growth of 95.4% in 2020, was, by far, the most successful sub-sector in monetizing new users during the pandemic. These services include remote software, but bundle that with complete desktop virtualization (running a complete operating system, usually Windows, providing a secure, familiar workspace). Workers in specialized, hardware-intensive industries like video production, 3D modeling, and game design struggled to maintain productivity away from the office. These companies could not rely on free or cost-conscious cloud services so were willing to invest in remote access to tailored hardware.

Remote desktops solve problems of compatibility as some of these workers would be specialized in a particular program that may not have close substitutes provided in SaaS packages. This subsector is expected to continue growing at 61.5% but shrinking its growth to match its peers with YoY revenue expansion of 30.7% in 2022 (Gartner). This subsector is relatively hardware intensive as the only constraint to expansion is server space. We see concentration levels remain relatively low in this sector as the high market cap firms focus on providing their established software suites over commoditizing their server houses.

Alternative service models such as PaaS (platforms as a service) and IaaS (infrastructure as a service) show similar growth patterns but represent a smaller segment of the overall cloud business model. These segments also experienced reduced growth in 2020 but are expected to return to rates of around 27% in 2021. 

Growing Importance of Cloud Services

Working from home in 2020 became the norm, making cutting-edge software suites a requirement for almost all service industries. Cloud computing divisions of these companies were expected to experience exponential user base growth as offices transitioned to daily video calls and secure cloud storage solutions. The biggest player, Amazon Web Services, grew 29% year-over-year, however, this represented the slowest YoY growth for the service since publicizing the division’s revenues in 2014. In fact, the cloud services sector significantly underperformed relative to market expectations, growing at only 6.1% YoY. This is assumed to be due to reduced corporate budgets for IT development as firms conserved cash during the recession.

As a rapidly growing industry, however, cloud service providers have been prioritizing user growth, making most of their services available for free. Investment in this sector remains very strong, however, with expectations high for service providers to maintain and quickly monetize their new 2020 clients. Revenues in this space are expected to grow at 18.6% over the next couple of years. The need for cloud computing and progress in cloud infrastructure has led to a growth in venture capital investment in high growth startups. These startups have been going public or getting acquired by big tech companies at a fast pace over the last decade.

Outlook on the Entertainment Sector

While software companies reaped the benefits of remote working, other firms struggled to cope with lockdowns and disrupted supply chains. Movie theaters were some of the hardest hit, expected to decline by 62.6% as the entertainment industry looked for profitable distribution means online. Media mainstays are still evaluating how to continue the distribution of their box-office movies going forward, the return of the theater industry will be directly decided by these decisions in the coming months.

COVID-19 accelerated the conversion rate of North American consumers to digital media. 2020 saw a record loss of $2.0 billion in traditional television revenues, simultaneously growing video streaming revenues by $7.3 billion. Statista’s forward-looking outlook for traditional television remains stagnant while online alternatives are expected to grow at a rate of 28.6% YoY over the next couple of years.

Outlook on Consumer Hardware Sales

Hardware manufacturers, while hoisted by demand for home offices, struggled with supply line disruptions, losing out on some of that surge and reporting an average increase in sales of 17.6%. Sales are expected to return to average growth of 8.3% in 2021 (expected to decline to 2.9% by 2024) as inventories build up again, but demand for personal electronics declines (Statista).

Due to the increased volume of sales online, hardware manufacturers and distributors benefited from increased margins on sales as long as they were established or large enough to maintain an online marketplace. We are waiting on confirming margin expansion statistics as these firms release 2020 earnings.

Beacon Mergers & Acquisitions is a full-service M&A advisory firm with offices across Ontario, Canada, and in Washington, D.C, U.S.A. Beacon also has a strategic partnership in the Asian subcontinent with Prime Bank Investment Limited. Beacon’s services include M&A advisory, debt financing advisory, and business valuations to private companies in the lower middle market.  Beacon is a three-time recipient of the Consumer Choice Award for Best Business Brokerage Firm in the Greater Toronto Area, and a member of several international M&A organizations.

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