Navigating Growth: Investment Opportunities in the Thriving IT Services Sector

Attractive investment opportunities

The IT services sector is characterised by recurring business models and high levels of growth in recent years, both of which make it an appealing area for investment. After an initial dip in revenues, the Covid-19 pandemic accelerated the adoption of digital products and services. While these effects do appear to be fading, the sector is still reaping the benefits as the demand for the outsourcing of IT services, IT infrastructure and software subscriptions remains high.

The move to the cloud, data centres, and the development of new IT services such as data and cyber security have also led to extra demand for Dutch IT. As a result, the sector has shown sustained revenue growth, totalling 9% YoY in 2022. The recent contraction we've seen was mainly driven by a decline in investment in IT equipment, and therefore shouldn't deal too much of a blow to the bigger picture.

 

The IT services sector displays sustained revenue growth after the pandemic

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Private equity contributions

Given its attractiveness to investors, it's no surprise that the sector is one in which private equity is very active. So much so that from 2020 to 2022, 52% of deals were backed by a private equity fund. Private equity-backed companies tend to follow one of two M&A strategies: integration and buy-and-build. The strategy followed partially depends on the investment horizon of the private equity fund in question.

 

In an integration strategy, not only are the back-end systems of the acquiring and target companies combined, but their processes and operations are also incorporated into one company following one strategic direction and brand. This strategy is followed by Arcus IT, Hallo and Rapid Circle. In the short term, integration takes more time and effort and consumes more resources from companies involved in the deal. However, in the long term, it makes it easier for companies to maximise their service proposition towards clients using cross and upselling.

 

In a buy-and-build strategy, only the back-end systems tend to be integrated while the different brands and company names are kept, bundling the knowledge and expertise from various companies under a business group. This is the case for Interstellar Group, Total Specific Hosting and Broad Horizon. Through this strategy, firms take advantage of the market tendency of assigning higher valuations to larger companies and benefit from multiple arbitrage*, without making many material changes.

 

*Multiple arbitrage means that multiples are higher for larger companies than for smaller ones when acquired. For instance, larger company A can acquire smaller company B at 5x EBITDA, but when A is then acquired by even larger company C, it is sold for 7x EBITDA. The EBITDA gained by A from the acquisition of B is an additional profit.