A crucible of headwinds is putting the world's M&A activities to the test, making 2023 a crucial year when the “reimagine” button is pressed. Particularly in the context of the technology services industry, which has witnessed record breaking deal activity in the past two years, there will be a momentary pause to reassess and recalibrate in response to the economic and geopolitical uncertainties.
The imperative of accelerating and sustaining competitive differentiation to gain market share with clients and access to talent, which has been the fundamental driver of M&A in this sector, will be more pronounced as end markets reprioritize spends. While growth rates for technology services industry are anticipated to slowdown from the past one to two years, IT spending is projected to increase and generate pockets of strong growth.
Strategic buyers have thus far focused on creating a differentiation across one or two of the three-dimensional axes of tech horizontals, verticals, and delivery models. The shift in terms of priorities is around “depth” and “specialization”. Assets that provide differentiated offerings would be in high demand. The offerings could be depth in tech stack via an IP-led or accelerator-led approach in rapidly growing areas such as data engineering, AI/ML, business analytics and decision support, hybrid/multi-cloud, Low Code/No Code, and hyper-automation. They may also be delivered through high degree of vertical specialization to solve core domain challenges in healthcare & life sciences, BFSI, manufacturing, retail and CPG, industrials etc.
Since 2020, private equities have been involved in over 600 transactions, with 7 ‘billion-dollar plus’ deals in 2022 alone. While large deal activity may be impacted from inflationary and credit pressures, private and carve-out opportunities will still offer enticing entry points for PEs. PE roll-ups typically constitute one-third to half (33-50%) of annual PE activity and will continue to stimulate deal activity with platforms revitalizing focus on accelerating competitive advantage.
With broad-based corrections in the public markets and reduced deal activity from 2021/22 highs, valuations in private markets are expected to remain under pressure for the rest of the year. Sellers are thus faced with a dilemma of either delaying their sale/exit processes in search of better market conditions or inking deals that optically provide suboptimal upfront/total returns. However, it is imperative to consider that the confluence of factors that led to valuation peaks of 2021/22 – from pandemic-infused digital demand to low interest rate environment – may be unrepeatable in the foreseeable future. Moreover, while the bar for premium has increased, sellers may still be able to command one by clearly demonstrating their competitive edge which may be driven from differentiation in technology or domain expertise.
A competitive process that leverages the resilient buyer appetite can maximize enterprise value across market cycle. Structured considerations, equity-roll over and similar structures can bridge the gap in valuations and help the sellers continue to scale their businesses as a part of larger platforms. Decision to sell, thus, is not a zero-sum game of handing over the swim lane to another but multi-tiered strategy balancing dilution with accelerating growth akin to swimming in a larger and faster current.
