Global Consulting M&A Review

Editor's Notes

• #3: First I’d like to tell you a little about Equiteq. I’ll be brief but I do want to say a little about: who we are; and How we think about the market, which influences our discussion today. Equiteq is an M&A advisory firm focused entirely on the consulting sector. So 100% of our work is done with clients who are consulting & prof services firms Founded in London in 2004 and we have a global presence across Europe, the US (in NYC office) and Asia Pacific (out of Singapore). We are different for 2 reasons: Consulting is in our DNA – We approach M&A advisory from a consulting perspective. We believe this allows us to provide better advice to our clients in this sector. We have: Expert groups – in London and New York that focus on Market Research and Deal Documentation; and Transaction experts – who lead deals and focus on transactional engagements. … (continues on the next slide)
• #4: (continued from the previous slide) 2) Second major point of differentiation is our ability to assist in the strategic equity improvement of our clients, through our knowledge of the sector and our proprietary Equity accelerator improvement program. On the screen you will see our framework for equity growth in consulting firms. This is: A proprietary model developed by Equiteq that is designed to provide consulting firm owners and shareholders with a scorecard of their equity value We use this in engagements where we prepare a company for sale, AND in deals to ensure we understand the value proposition of a firm and preparedness for sale, before we take them to market
• #6: So enough about us… What I’d like to talk to you about today is an overview and commentary on our recently published 2015 Global Consulting M&A report, which you can find on our website. This is the latest iteration of this annual report, in which we track all consulting firm transactions across the globe and provide data and insights on a broad spectrum of M&A activity within and across the consulting sector. While the full report covers significantly more than we have time for today, I do want to provide you with an overview and the material points coming out of recent M&A analysis in this space. So this will cover: Our current market for consulting M&A, as evidenced by recent transaction activity; and What this tells us about the relative health of the market for the sale of consulting firms;
• #7: So to that end, we hope that today’s webinar will provide you with some additional perspectives, commentary and context on the information in our report. So the key topics today will include: Trends in the macro economy and how this impacts global consulting transactions; We will provide an outline of global M&A activity, including transaction volumes and values, deal structures and strategic and investment buyers; We will talk about some regional considerations for consulting M&A transactions; And we will cover major trends in the core consulting sectors; We will then wrap it up with some outlooks and implications for the balance of 2015 and beyond All of this is intended to outline the current market for M&A across the consulting landscape and provide some intelligence for those considering a transaction at this time
• #8: So with that, it is important to contextualize this discussion with an outline of the relative health of the M&A market as a whole. This chart reflects the value of M&A deals across all industries, globally. The point is that - coming out of the recession, since 2010 we have seen a very healthy, global M&A market. What that means is that the current global environment is broadly supportive of transactions. Now that doesn’t mean a lot for any one specific company, BUT: In the environment we’re in (experience a couple of recessions in our recent history where transactions have dropped off a cliff), it is important to understand that following the credit imbalance that occurred in 2008 and 2009, since 2010 we have NOW entered a market where there is very steady and healthy transaction activity. Based on the global M&A data, it feels to us like a very healthy market. And one in which willing sellers and buyers are both seeking a transaction. Also on trend – Corporate buyers are broadly rich in cash and looking to deploy capital to grow. If you think about large global firms, there is a healthy appetite and recognition that they need acquisitions to grow, and that organic growth is limited as a means of satisfying the strategic initiatives of the shareholders of the company. SO this is a broadly positive picture for M&A as a whole.
• #9: Narrowing in on the consulting M&A market, In this chart we show the number of monthly deals in the consulting sector (globally) and a 12 month moving average to highlight the trend. What is important to note is that similar to the prior chart, monthly consulting deal activity has resumed following the downturn in 2009 to roughly 200 consulting deals per month. This is reflective of a healthy consulting M&A environment, where deal activity is steady… Although deals will fluctuate per month, with spikes near the beginning of each year, there is no significant volatility in this market. What is interesting in this chart is that EVEN in the 2008 / 2009 period, which was by far the lowest level of deal activity in the consulting market, there were still 100-150 deals occurring in this space per month! If you compare this to global M&A data for the same period, you would see a much steeper drop. What this tells us is that consulting firm M&A activity has been relatively more defensive and less subject to the cyclical swing. We have found this to be true in the history of tracking this data, which now reflects a very steady and stable M&A market for consulting.
• #10: Looking at the long term annualized trend, this also paints an interesting picture. You’ll see from the chart that global consulting M&A deal volumes have also been consistently above 2000 deal per year since 2009. However, while we see a clear recovery in the number of consulting M&A transactions following the credit crunch, we actually saw a slight dip in activity across all sectors and regions in 2013, thereafter trending upwards again in 2014. This may call into question the stability of the recovery, but a few key reasons for this seem apparent: While there were fewer deals in 2013, there was a relatively high proportion of big deals For example, PwC’s funding had slowed down in 2013 in anticipation of the Booz & Co acquisition in 2014. Also, Deloitte bought Monitor in 2012 and this would have slowed down its acquisitions Furthermore, values were rising significantly in 2013 and this had an overall affect of slowing down deal activity However, we saw that volumes recovered from this small dip in 2014, while values still remain high. While some macro-economic uncertainty started entering the market in 2014, including falling oil prices, lingering difficulties in continental Europe and Japan, and a slower rate of growth in China, the increasing strength of the US and UK economies supported a healthy level of growth in consulting M&A globally.
• #11: We are often asked by some clients about whether they are big enough to be considered for a transaction – the implication being that only firms of a certain size are capable of being acquired. The reality is that within the global consulting industry, a large majority of acquisitions are in fact small-value deals. What we saw in 2014, which is a consistent story year on year, is that about 35% of reported acquisition values were under $5m and 70% under $40m. What this tells us is that the consulting industry as a whole is not only dominated by small firms, but that there is a constant supply of small consulting firms entering the market that are quickly acquired if they succeed, otherwise they can stagnate, are not acquired and/or fail. This aligns with our own experience that growing consulting firms face a number of ‘glass ceilings’ in their growth at the smaller end of the market. Those that manage to break through these glass ceilings tend to be prime targets for acquisition at each level. So press coverage will always favor the large-value deals - this is what we read about the most. But the fact is that there are relatively few consulting firms sold that are above $100m in revenue. Also, as an owner of a small but growing consulting firm thinking about a transaction, it is important to note that the small value deals in the market do not often include large buyers. These deals are typically more of a merger than an acquisition, with little cash involved. This is something to keep in mind for consulting firms at the smaller end of the spectrum here looking for an investor or sale of their firm.
• #12: So let’s talk about the global picture for consulting M&A multiples – basically these are indicative metrics for transaction values in the market. I’d just like to remind you at this point that we’re still looking at an aggregate picture of values across all consulting capabilities and regions, in order to highlight how the industry is doing as a whole. Before I begin, it is worth noting a margin of error that tends to be associated with reported deal multiples. First it is important to remember that multiples are simply a proxy (or back calculation) for the value of a company. Several factors such as growth, profitability, cashflow, and synergies all contribute to the value of a company, so simply saying that a firm is worth, say, 8x EBITDA is not a valuation – it is a back calculation of the price paid as a proportion of EBITDA to contextualize the relative price. Also, multiples reported in the market can look inflated compared to what we see in practice. This is because the price paid for a company is typically based on the forward looking figure (not available to the market), whereas reported multiples are based on the last annual figures (available in the market). As companies that sell tend to be growing, a multiple of price based on the previous years financials will look larger than a multiple based on the current or future year’s financials. So it would be dangerous to simply assume that the reported multiples can be applied to the financials of your firm to arrive at an indicative value for your firms. What we can do is look at the trend in multiples to get a sense of whether values across a sector or region are increasing or decreasing. So the take away here is more about the trend than the absolute multiple. What we’re looking at here is a chart of the annual median EBITDA and revenue multiples for all consulting deals globally. We do this to get a sense of how values across the industry as a whole are trending, which is broadly useful when comparing against other industries. So as we saw before, trends experienced a dip during the crash and have slowly climbed back to pre-crisis levels, following a short dip in the intervening period.   In 2014, there was an net upward trend in EBTIDA multiples across the consulting sector, with revenue multiples remaining steady at a 5-year high. Against the backdrop of growing deal volumes in 2014, this highlights an overall seller’s market, where demand from buyers is exceeding supply of sellers in the market, ultimately keeping values high.
• #13: So in our report, we also track the top strategic buyers of consulting firms across all major disciplines. Interestingly in 2014, 3 of the top 5 most prolific buyers of consulting firms were in fact in the media sector, namely WPP, Publicis and Omnicom, 3 of the top global media firms. We know that these firms have historically been frequent acquirers of media advisories and marketing agencies. But what the 2014 data shows us is the ongoing need for media firms to enhance their technology capabilities, in line with the ongoing impact of digital / social (online) media, customer analytics and cloud-based services that have become common place in the media industry. This means that media firms have needed to broadened their scope of acquisitions to include advisory firms in IT, media and management consulting. We also see that of the Big 4 accounting and consulting firms, namely PwC, KPMG, Deloitte and EY, who are consistently amongst the most prolific buyers of consulting firms each year, KPMG made its way into the top 5, beating out the others. We know that these firms are in perpetual competition with one another, and this translates into their deal activity year on year. So we know that KPMG had significantly increased their acquisition activity globally.
• #14: Now I wanted to also highlight a point about investment or financial buyers in this space – effectively the interest of Private Equity in the consulting sector. So consulting or professional services has not historically been a popular sector for Private Equity investment. This is apparent in the historically low proportions of Private Equity involvement in consulting sector acquisitions. Buyers of consulting firms are largely larger consulting firms or other large corporates. From an investor’s perspective, the consulting sector can be perceived to suffer from factors such as: Difficulty of sustaining and forecasting project based work; Reliance on people as the core assets of the company – assets subject to change and attrition; Limited potential for recurring revenue; and Challenges in scaling – with limited operating leverage. While these are some of the potential risks when investing in poorly run consulting firms, those that are well run not only mitigate these risks, but also benefit from many attractive financial aspects of the consulting business model, including: Relatively high levels of profit; Low working capital requirements; High conversion of profits to cash; As the economy has improved, so the proliferation of Private Equity investments in the market has increased. This has created a relative abundance of available private equity ready to be deployed and also pressure to deploy previously undeployed equity. This creates competition amongst PE buyers, who can become commoditized in a competitive auction against strategic buyers. As this has happened, the PE industry has looked to invest in non traditional areas, with a more open appetite towards consulting sector investments, in order to find returns. And we have tracked this year on year. You’ll see the affect here in this chart, as the increasing proportion of Private Equity lead M&A activity in the consulting sector vs. Strategic buyers. In fact, 2014 was a record year for PE in consulting, as 15% of all global consulting deals were done by PE firms. This is a good sign for sellers, for whom PE buyers provide additional options for the right firms.
• #15: To wrap up this section on global consulting M&A trends, it is worth a note here on deal structures. Buyers of consulting firms typically do not like to pay all of the purchase price as an upfront payment, in order to avoid the risk of the human assets walking out the door after they get paid. So buyers often provide a proportion of the purchase price as an upfront payment and have the remainder paid as an earn-out over a number of years based on certain metrics (performance of the firm, retention of staff, etc.). A key question for sellers thinking about a transaction is what proportion of your firms value could you expect to be paid on Day 1 of a completed acquisition. So what we’ve seen in the market in 2014 is that the average upfront payment being 60% of the total value, with 40% remaining as the earn-out. As another consideration, separate from the analysis here of deal structure reported in the market, we have also anonymously surveyed approx. 100 buyers of consulting firms to understand their deal structure preferences. These buyers have said that 45% - 50% of the total purchase price is paid upfront over a 2-3 year period. This is also in line with what we seen in practice with some of our own clients. So based on the market data, we see an average of about 50% to 60% upfront payments for consulting deals, with the balance structured as an earn out.
• #16: So with that coverage of global context, let’s now take focus on some regional considerations
• #17: Firstly, it is interesting to note the dynamics of cross border acquisitions in consulting and the countries where buyers are more likely to look abroad for acquisition targets. We know that the top 10 countries by deal volume account for over 80% of deals done around the world, and cross border deals account for 19% of all transactions. However, it is important to consider why some buyers look abroad for acquisitions vs. others who prefer to acquire in their own market. The graph on the left shows the proportion of deals where buyers are from outside of the listed country. Now we know that the US consulting firms are often a target for foreign buyers so it may seem strange that only 12% of US firms are sold to international buyers, but its important to remember that the US is also the largest market for consulting M&A transactions, so the 12% represents a large absolute number. Countries like Japan and France also had a small proportion of firms sold to foreign buyers in 2014. This can be explained by the economic slump that Japan was in and the relatively localized nature of the French economy, which made investing in those countries less attractive. Its also interesting to note that China’s consulting market had a large proportion of foreign buyers, who were largely from the US, UK and Singapore. It may not be surprising to hear that Canada’s large proportion of deals with foreign buyers were from the US, and South Africa’s foreign buyers were largely from the UK and US. Conversely, the graph to the right shows the proportion of deals where the TARGET is from outside of the listed country, effectively these countries looking internationally for consulting acquisitions. So China and the US are on the bottom of this list, as these markets are big enough to fulfil the internal buyer demand for target acquisitions, whereas a country like the Netherlands has more buyer demand than its supply of consulting firms, so Dutch buyers largely look internationally for consulting targets. There are some obvious factors like the size of the acquiring company, the size of the geographic market they’re in, the desire for geographic diversification, and others that influence a buyer’s decision to look abroad. But it is clear that when most buyers look internationally for acquisition targets in the consulting sector, countries with proximity in terms of culture, economics and politics have a greater influence on their decision than, say, geographic proximity. So for instance, foreign buyers of Australian consulting firms largely come from the UK, a country on the other side of the world, but whose economy, politics and culture are very similar. As a firm thinking about selling your business, it is important to consider whether or not you would be attractive to a foreign buyer looking to enter or expand in your regional market, and if so, consider the cultural implications of having a foreign corporate parent.
• #18: So as I’ve mentioned before, the largest markets for consulting sector M&A deals are the US and the UK, so we track these markets quite closely. Let’s first lets look at what’s happened in both the US and Canada, as the two economies have very close trading ties. North American consulting deal volumes increased by a very healthy 21% in 2014, following a similar dip in 2013 we saw before. However, you’ll see by the graph here that we are now at a 9-year high in terms of deal volumes. The vast majority (93%) of these transactions happened in the US, which itself had a 23% increase in deal volume. We saw that the US economy gained some momentum in 2014 after a relatively sluggish 2010 to 2013. Now we can see here that consulting deal activity has been healthy from 2010 to date, but factors like the increasingly well performing equity and credit markets, increased consumer confidence, low borrowing costs and high corporate cash reserves helped to really fuel M&A activity in consulting in 2014 to a 9-year high! The multiples are at standard levels in terms of revenue and slightly below the 5 year median value in terms of EBITDA. So lets just take that in for a moment. The largest market for consulting M&A has just had a record year for deal volumes. This reflects the fact that it is currently a great time to be selling a US based consulting firm, as we’re in a very liquid market where buyer demand is currently very high.
• #19: European consulting M&A is a source for growth in the overall global consulting M&A market. European consulting deals account very roughly for about a third of all global consulting deals by both volume and value, and Europe is STILL the second largest consulting M&A market in the world. I say STILL because despite the growth of China, India and others in the Asia Pacific region, Consulting M&A activity is still less likely there than in Europe and North America. As some of you may have guessed, the UK is the single largest proportion of consulting deals that happen in Europe. The UK has seen a steady upward trend in consulting M&A relative to all of Europe. Following the 2009 dip, UK deal volumes have seen a much greater rise year on year, and they continued to rise through the 2013 European dip. This highlights the ongoing health of the UK consulting M&A market and its resilience against a recent slowdown in the rest of Europe. And looking at the breakdown of European consulting M&A volumes from a different angle, it becomes clear how much the UK dominates the European consulting M&A market. It is about 3x larger by deal volume than France, a distant second, and 4x larger than Germany. The trend in deal multiple improved in 2014 with EBITDA multiples up 16% from the long term median. So once again, this points to the health of the consulting M&A in the second largest region for consulting deals globally.
• #20: So the core of our analysis focuses on trends within the major sectors within the consulting industry. Now unless you a large diversified consulting firm, one or two of these sectors is likely to be relevant to any one of you, and so we only have time to briefly cover each one. However, I would encourage you to download our report if you’ve not already done so, because we have a lot of focused analysis in each section that is likely to zero in on your specific area.
• #21: So we segment the consulting industry into 5 very specific areas, which are: Management consulting IT consulting and Technology services Engineering consulting Media; and Human Resources consulting. Of course we go further in our analysis to sub segment these core buckets, but these divisions tend to cover most of the firms we look at and advise. The first thing I want to outline to you about M&A across these core sectors in consulting is where most of the deals happen. The pie chart on the right reflects the proportion of deals done in 2014 in each segment, but these proportions remain fairly stable per year.