ShoreGroup Inc. had been approached by strategic buyers in the past, but when the supplier of software and networking management services to cloud and hosted solution providers received a growth equity investment of an undisclosed amount in June, it was from Francisco Partners Management LLC, a San Francisco private equity firm.
“The reason we went with private equity is because they’re positioned [towards] growing the company,” said ShoreGroup CEO and president Robert Kennedy.
He noted that Francisco Partners’ vision for the future, and the fact that it pledged to keep the company intact and growing it, is what sold ShoreGroup’s management.
Francisco Partners’ investment is only the most recent in what’s become an 18-month trend during which private equity firms have been aggressive bidders in auctions for managed services and cloud services providers at the middle-market level.
Managed services providers outsource IT services and guide customers that typically lack an internal tech team by providing a large portion of infrastructure functionalities, whether that be providing equipments or supporting servers. Cloud services providers, meanwhile, offer subscription-based services that expand aforementioned IT capabilities via the Internet.
“These businesses have grown quicker and have thrown off a lot of Ebitda, improving returns and providing for attractive leverage,” said Michael Quinn, founding partner of telecom-focused boutique investment bank Q Advisors LLC.
He noted that private equity firms or PE-backed strategics have been a leading bidder in every telco services auction he has led during the past year or so.
“There’s really a crossover. It’s difficult to tell where technology ends and where telecom starts,” Quinn said. “But more and more PE firms are chasing these deals.”
Strategics has stolen a march here or there, but only really on larger deals. Digital Realty Trust Inc. (DLR) is writing a hefty check worth nearly $2 billion to grab Telx Group Inc. from the data center operator’s private equity sponsors of four years, Abry Partners LLC and Berkshire Partners LLC. Meanwhile, Redwood City, Calif., data center operator Equinix Inc. (EQIX) crashed a $2.2 billion tie-up between TelecityGroup plc and Interxion Holding BV by offering $3.6 billion for Telecity in a bold move to enter the U.K. market. Otherwise, PE firms have really dominated M&A in various parts of the telecom services space.
Managed and cloud services providers, for example, have been and will continue to be one of the focus areas for PE over the next couple of years, said Stephen Meredith, a corporate partner at Locke Lord LLP.
Meredith, who advised data center company Latisys Holdings LLC in its $675 million sale in February to Zayo Group Holdings Inc. (ZAYO), which is 65.6%-backed by PE firms GTCR LLC, Oak Investment Partners LP, Columbia Capital, M/C Partners, Charlesbank Capital Partners LLC, Communictions Infrastructure Investments LLC and Battery Ventures LP, explained that financial sponsors started dipping their feet a few years ago in data centers, which are facilities with hardware and equipment that physically handle information storage for organizations.
PE houses started with old-fashion data centers before shifting gears to pursue providers of newer, complementary features involving managed and cloud services, he added.
For instance, in 2011, Boston PE firm Great Hill Partners LLC invested in Ascenty LLC, a provider of data center solutions such as co-location, managed hosting and cloud computing. Ascenty primarily serves corporate enterprises and wireless carriers in Brazil. Also that year, Boston PE firm TA Associates Management LP acquired managing hosting and co-location services firm Cosentry LLC.
In 2012, Canadian data center operator Q9 Networks Inc. was sold to BCE Inc. and a consortium of PE firms including Ontario Teachers’ Pension Plan, Providence Equity Partners LLC and Madison Dearborn Partners LLC in a hefty $1.1 billion buyout. (Chicago PE firm Madison Dearborn in June returned to the scene, buying a majority stake in managed web hosting company Liquid Web Inc. following a nine-month-long strategic review.)
Last year, San Francisco middle-market PE firm GI Partners acquired IT infrastructure and cloud provider Peak 10 Inc. through its GI Partners Fund IV LP. And Boston PE firm M/C Partners invested $50 million in IT services company Involta LLC.
M/C Partners has been particularly busy this year. Besides its involvement with the Latisys deal, it acquired a majority stake in cloud and managed services provider Denovo Ventures LLC in April. In May, it joined forces again with Charlesbank Capital to obtain IT infrastructure management business from data and marketing services company Acxiom Corp. (ACXM) for $190 million.
That PE firms are so attracted to managed services space isn’t surprising, given companies’ strong cash flow and growth prospects. “They have recurring revenue, are scalable, have good Ebitda margins and stable revenue,” Meredith explained. “They have the ability to roll up businesses. It’s a continuation of a trend, but I do think that the incredible growth in telecom services and especially outsourcing people’s computers —-that IT function—-has really created demand. PE loves nothing more than recurring revenue model in a quickly expanding market.”
The initial wave of the deal activity occurred within the co-location segment, said Brian Pryor, Managing Director at San Francisco-based Media Venture Partners, referring to the practice of organizations sharing facilities with data center offerings as tenants rather than owning the operations themselves.
“People have gotten more knowledgeable and more comfortable with everything going on higher up the IT stack, like hosting and cloud services,” according to Pryor, who leads the telecom, media and technology-focused investment bank’s data center and hosting practices.
For financial sponsors targeting the middle market, $5 million of Ebitda has become an important threshold, Pryor said. PE doesn’t get as aggressive for businesses with less cash flow unless there is near-term dynamic driving scale or evidence for further growth, he added.
“There’s another valuation break at $10 million of Ebitda, largely driven by even cheaper debt and scarcity of inventory,” Pryor said.
Growth is a particular accelerant for deals. When Francisco Partners was introduced to ShoreGroup’s management last year, ShoreGroup was at a crossroads on how to approach its growth, according to Andrew Kowal, a partner at Francisco Partners.
“We had a number of meetings with the management team and began to develop a shared vision for the future of the company,” Kowal explained. “As our dialogue evolved, we put a more formal offer in front of the team in March and signed a definitive agreement two months later.”
Francisco Partners’ quick work is pretty much indicative of how aggressive the firm has been this year. It took communications equipment maker Procera Networks Inc. and software vendor ClickSoftware Technologies Ltd. private through deals of about $240 million and $438 million, respectively, earlier this year after closing the $2.88 billion Francisco Partners IV LP fund in February. It has also acquired HealthcareSource HR Inc. and SourceCode Technology Holdings Inc. this year.