Increased adoption of cloud-based technology
Inevitably, as many industries were forced to work remotely - becoming almost entirely reliant on virtual communication - we saw dependence on technology solutions increase significantly around the world.
This has forced many businesses and users to migrate from legacy applications and infrastructure to more modern technology in order to accommodate a predominantly virtual workforce. In fact, vendor revenue from the sales of IT infrastructure products for cloud environments worldwide (including public and private cloud), increased 2.2% in Q1 2020 in comparison to investments in non-cloud infrastructure, which saw a reduction of 16.3% year-on-year.
We believe that the key trends driving cloud-based technology adoption – and thus, investment - are clear:
- A need for extra capacity – as businesses continue in their flexible working, there is expected to be an increase in demand for cloud-based storage and sharing platforms. This could encourage M&A activity in the space as legacy IT infrastructure firms look to expand their offering into cloud-based technology to capitalise on this rise
- Increased reliability – more dependable options for business continuity could lead to further cloud-based technology integration moving forward, with a view to support business growth through efficiency
- Flexibility and scalability – switching to a ‘pay as you use’ model, which offers a more flexible approach for businesses, especially as demand fluctuates in periods of recovery
- Cost-cutting – reducing on-premise data centres and migrating to the cloud in order to reduce headcount. This could initiate increased M&A activity in the space where companies are able to outsource, through cloud migration and sharing platforms, supporting growth trajectories and in turn attracting investment
Businesses are actively adapting to this increase in demand for cloud-based technology. This demand is not only being driven by business’ remote working agendas, but also through the rise of e-commerce and demand for online services, such as takeaway food and shopping deliveries. Azure, a cloud computing service created by Microsoft, has expanded their offering into other geographies in order to launch new partnering and service opportunities. This move should offer Azure greater exposure to investors and smaller firms as possibilities for growth.
With cloud-based technology adoption easier to test and implement compared to the legacy IT infrastructure, and with the increased consumer usage and digital or remote working capabilities becoming a part of the ‘new normal’, we expect the market to continue its growth trajectory as businesses recover and adapt to more flexible working structures.
Driving the demand for high-end consulting and managed services
There are, however, limitations when it comes to the migration to cloud-based technology; the current lack of resources, and a risk of security and compliance are all factors of consideration with the migration. Further to businesses’ increased focus on operational expenditure, we have noticed a rise in demand for managed service providers (MSPs) and high-end consulting, who provide an end-to-end offering and help to mitigate costs. According to Flexera, nearly 50% of organisations currently use MSPs for their public cloud usage.
This increased demand for managed services is driving M&A in the space, with legacy IT service providers looking to acquire smaller niche IT Services specialists. According to Pinsent Masons, 49% of European M&A deals have been more buyer-friendly due to Covid-19. We believe that this drive in M&A could potentially be causing the valuations of smaller firms to spike, as legacy providers look to adopt boutique businesses before they are able to adapt to market conditions.
We believe that corporates will continue to leverage M&A as a strategic tool to accelerate their roadmap to digitalisation. With the current pressure on global economies resulting in lower interest rates, private equity operators are more likely to consider investment, and with communication and next generation technology-focused firms seemingly more resilient through the crisis, they could see potentially higher-yield returns in the space. There is, however, a concern around the sustainability of the inflated profit margins of companies operating in this market longer term.
In line with most domestic economies’ heavier dependence upon cloud-based technology, and the evolving IT threat, resulting from remote working during the pandemic, international governing bodies also seem to be focusing more efforts in the sector.
Government spend on IT related technology in the US is expected to reach $89.3bn in 2020. The pandemic is also driving the focus on IT Services in health & human services and education, with an enhanced necessity to modernise the technology in these areas in response to the growing need for speed and efficiency. We also expect IT Services in Europe to benefit greatly from the European Covid-19 support funds; for example in Spain, a large portion of the funds will be invested into digitisation.
With the future of the IT Services market expanding through innovations in cloud-based technology - AI, VR and the rise of 5G, for example - we expect the emergence of unicorns and the smaller companies working on these new technologies to become more attractive to venture capitalists, private equity houses and corporates, once matured. In addition to this, we expect government focus to support this trend, with a means to recover global economies by encouraging innovation and tech-development.
As global economies move into the next phase of lockdown measures and whilst the true impact of the pandemic is yet to be seen, we expect deal activity in this space to pick up in H2 2020 as inclinations to invest increase.
We also anticipate that investors from geographies with much faster recovery patterns could begin to pursue technology M&A opportunities, even in areas with slightly slower recovery outlooks. For example, Asian economies are expected to recover faster than the West, and thus Asian investors may look to acquire Western assets in order to capitalise on the disparity.
In order to remain active in the space, sector operators should:
- Focus on the developments in cloud-based technology
- Review opportunities for consolidations within MSPs
- Maintain a regular review of government legislations in cloud-based technologies and opportunities to invest
 Microsoft launches new cloud computing services in UK Azure regions. Microsoft. 22 May 2020.