Many corporates will have revisited several aspects of their operations as a result of the pandemic. To facilitate this, business services, which allow companies to use experts in certain aspects of how they are run and focus on their respective unique selling points, are going to be in demand. Business services delivered steady deal flow for corporates and private equity.
According to Refinitiv, there were 740 global business service deals in 2021, totalling $44.5bn – the second-highest annual deal value recorded by the sector since 2010. The highest was in 2017, with $45.5bn of M&A worldwide. Last year, there was $20.6bn-worth of business services deals.
UK dealmaking in the sector proved equally buoyant. Deal value grew from $4.7bn in 2020 to $6bn last year – the highest annual total.
What has been especially telling, however, is not the scale of the rebound in business services dealmaking in 2021, but the fact that the sector barely registered a blip throughout the volatility caused by COVID-19 in 2020. Global business services deals were only marginally down on the $21.8bn posted in 2019 (and $21.2bn in 2018), while in the UK there were only $775m-worth of deals in business services that year, due to there being no mega-deals involving British companies.
The strong performance mirrors the broader resilient performance of the sector, with the MSCI Europe Commercial & Professional Services Index showing gains of 12.28% for the 12 months to the end of January 2022, after delivering positive returns for investors in both 2020 and 2021.
It’s very difficult to tell what impact Russia’s renewed invasion of Ukraine will have on the world economy – and, in particular, on that of the UK. But the long-term outlook for business services remains relatively bright.
Usman Malik, head of business services in Grant Thornton Corporate Finance Advisory, explains that this is “a very broad church and comprises a wide range of companies operating across a spread of industries. It’s a diversified sector that’s often shielded from economic uncertainty due to the nature of the companies it spans. Business services companies generally deliver regulatory-driven, non-discretionary services that customers can’t switch on or off, so earnings have held up robustly throughout the pandemic period.”
Chris Hunt is head of M&A at FTSE 100 pest control and commercial hygiene service provider Rentokil Initial, and is a member of the Corporate Finance Faculty’s board. He says: “There’s a great deal of excitement around subscription revenue models in the technology sector, but the business services industry has been doing this for decades. Between 60% and 80% of our revenues are recurring. A business that provides an essential service to happy clients will be able to secure long-term contracts and clear visibility of earnings.”
These steady, repeatable earnings and sticky customer bases have meant the sector has always been popular with dealmakers.
Richard Pulford, M&A partner at EY, says the fact that the industry is people-led, with low barriers to entry, means it sustains high levels of M&A: “Business services companies are asset-light and you don’t require huge amounts of capital to set up a new company. It’s much easier to start up, grow, scale and exit than it is in other industries. There’s a regular cycle of people and small teams breaking off from larger entities to build their own companies and then sell on to private equity or trade when they reach a certain threshold.”
A steady stream of deal targets has made it even more highly prized, intensifying demand for high-quality business services assets.
Neil McManus, head of business services in KPMG’s UK corporate finance practice, says: “Some end markets suffered badly, and institutional capital was directed away from these toward more resilient markets such as services. Business services volumes and values have held up well and the market has adapted to the challenges created by the pandemic, which has, in many instances, created opportunity for services businesses. The sector has also not faced such significant disruption as some markets throughout the period.”
Against the clock
For private equity in particular, business services has been a go-to area through periods of turbulence. According to Preqin, UK private equity firms are sitting on a record $1.32trn of dry powder. There’s been a flight to quality during the pandemic, with firms clustering around business services assets in order to keep their capital deployment timetables on track.
Refinitiv data show that five of the largest business services deals announced in 2021 involved a private equity sponsor or consortium on the buy side. The largest buy-out-backed deal in 2021 saw EQT move Swedish-based pest control company Anticimex to a longer hold fund for $7.2bn. It had flirted with the idea of an IPO.
The low barriers to entry and the fragmented nature of the market have also made business services a perfect fit for increasingly popular private equity buy-and-build strategies. According to McKinsey, add-on acquisitions historically accounted for 40% of private equity deals.
In a competitive market characterised by high entry multiples, buy-and-build strategies have offered financial sponsors an opportunity to buy up smaller businesses. They typically trade for lower multiples than bigger assets, according to Bain & Co, then combine them into a bigger entity that can be sold at a higher multiple on exit. Business services has been one of the most popular sectors for this strategy.
Pulford suggests: “If you were to map out the portfolios of all active private equity managers, you’d find that pretty much every firm would have at least one platform company in the business services sector following a buy-and-build strategy. There’s extensive scope for consolidating smaller business services companies and building scale by adding new capabilities and customers to a platform investment.”
For trade buyers, M&A has also continued to appeal, despite pandemic uncertainty. Rentokil Initial’s Hunt says that after a brief pause following the first COVID-19 lockdowns, his team was back on its pre-pandemic run rate of about 40 to 50 deals a year by the second half of 2020, including in 2021 a $6.7bn deal for US pest control counterpart Terminix. (see box, ‘Cleaning up’).
“As a strategic buyer, we’ve been able to take a long view on the quality of an asset and get comfortable with a valuation without relying exclusively on current earnings, which is much more important for a financial buyer that has an investment horizon of around five years,” Hunt explains. “We know the market and who the quality players are. We’ll look at how a target prices its services, what its profit margins are, the quality of customer services and the density of its client base, rather than just focusing on the last three months of earnings. We’re good at identifying where the synergies across sales, the web and the back office lie, and that’s enabled us to continue doing deals.”
Pulford notes that the long-term drivers behind growth in business services have persisted during the pandemic, encouraging strategic buyers to lean into these trends and continue investing in acquisitions that have a sound industrial logic.
The rapid digitalisation of service delivery has accelerated too, while environmental, social and governance (ESG) has become a key driver of growth, valuations and deal activity, explains Satvir Bungar MBE, a corporate finance managing director and head of business services M&A at BDO.
“ESG is now very much at the forefront of the investor agenda,” he says. “What’s been interesting to observe is how ESG is now correlated to qualitative financial value. Due diligence, for example, is now interrogating climate change risk for site locations and the impact on insurance premiums. Buyers are appraising ESG in greater depth.”
But ESG isn’t exclusively about limiting downside risk – it’s also opening up new growth opportunities for business services companies, with M&A a key tool for unlocking new ESG-driven revenue streams.
“The focus on climate change has driven a meaningful uptick in demand in areas such as insulation maintenance and electric charging point installation and upkeep, opening up new revenue streams and driving deal flow,” Bungar says. “For example, Mitie – the UK’s leading facilities management and professional services company – acquired independent connections provider Rock Power to expand its electric vehicle charging point infrastructure.”
Pulford says: “The digitalisation of business services was already under way before COVID-19 and has accelerated since. The focus on sustainability is at the forefront of every business’s agenda. Creating growth opportunity for services and increasing government regulation in areas such as testing, compliance and employment law, is increasing demand for external help and support. These trends are entrenched in the sector and driving long-term growth.”
As pandemic risk recedes, the long-term trends in business services are expected to sustain investment appetite from private equity and corporates.
Grant Thornton’s Malik says the focus across the industry now is on identifying where the growth verticals lie within business services and which sub-sectors will emerge as the strongest following lockdowns.
“As business services is such a broad sector, it can be misunderstood. The sector as a whole may perform really strongly, but there will be sub-sectors that are doing less well. During the pandemic, for example, areas such as catering services were hit, while there was an uplift in demand for services across environmental and hygiene sub-sectors, as well as technology-led services. Investors are now sifting through to determine which areas that received a one-off COVID-19 boost were impacted by lockdowns but are rebounding strongly.”
Recruitment in verticals such as healthcare and logistics and transportation, for example, is performing very strongly again as healthcare backlogs and supply-chain pressures take hold. Facilities management deal flow has also picked up materially during the past 12 months, according to Grant Thornton’s research, with strong interest from private equity in the regulated fire sector and technology-led security sector.
Investors are expected to continue getting behind the digitalisation and automation of the delivery of business services. According to a McKinsey survey of 50 global business services companies, 90% had scaled up their remote-delivery infrastructure through the pandemic without compromising customer service.
With McKinsey also expecting automation to have an impact on up to 60% of all jobs by 2030, the people-centric services space is in the process of a significant digital transformation.
This is already playing out in the deal market. Private equity firm Freshstream, for example, backed Themis Risk, a provider of remote CCTV monitoring as an alternative to on-site security guard services; ESO backed Arcus FM, which acquired BEMS to deepen its remote monitoring capability in the energy, refrigeration and heating, ventilation and air conditioning spaces.
KPMG’s McManus says: “COVID-19 has been a catalyst for accelerating long-predicted changes to how businesses provide services to customers, which in turn increased the demand for services that enable such change. This significant market driver is helping to underpin M&A appetite.”
Hunt, meanwhile, says the global demographic shift of populations into cities, rising living standards in emerging markets and more stringent regulation in areas such as food hygiene and chemical usage will support ongoing M&A for corporates that want to unlock synergies and expand in new geographies.
“There are great opportunities to buy growth in domestic and global markets. For business services companies providing customers with consistent, high-quality service, this a good time to be expanding through M&A.”
Why business service deals are so attractive
In 2016, after a hold period of just over three years, UK private equity firm ECI secured a 5.4x money multiple from its sale of Citation, a provider of HR, employment law and health and safety services to SMEs, to buy-out house Hg in a secondary buy-out.
ECI supported two bolt-ons to Citation and rolled out an online customer interface that allowed clients to manage all their HR and health and safety compliance through a single portal.
Hg proceeded to work with Citation to double the group’s customer base before securing an exit to KKR in 2020 and taking up an option to reinvest in the company a few weeks after the sale.
EY M&A partner Richard Pulford says investment in Citation by ECI, then Hg, and then KKR demonstrates why business services deals hold such strong appeal to private equity investors, and how firms can add value to platform business via acquisition and investment in technology.
“Citation is a perfect example of the private equity business services investment template,” he says. “You have an asset in a fragmented, compliance-driven market where private equity investors have expanded the business through acquisition and invested in technology to grow the customer base and differentiate the client experience.”
The world’s biggest pest control business
At the end of 2021, UK-listed pest control and hygiene group Rentokil Initial announced its plans to acquire US counterpart Terminix in a $6.7bn takeover, to form the biggest pest control business in the world.
For Rentokil Initial, a sophisticated corporate M&A investor that has closed more than 220 acquisitions, the deal represents one of its largest investments in recent years and demonstrates how business services dealmakers see opportunities to expand their franchises into new markets that are supported by universal growth drivers.
The global pest control market is worth $22bn globally, according to the Financial Times, and saw sustained growth through the pandemic as a globally expanding middle class and increasing concern about hygiene and diseases drove demand in countries around the world.
“Rentokil has been active in the US market, with a strong presence in commercial pest control and the regulated food and pharmaceutical markets. Terminix has a strong residential and termite business, so the two companies are a good fit,” says Chris Hunt, head of M&A at Rentokil. “There’s a solid industrial logic to the deal. By combining infrastructure, the businesses will be able to put technicians closer to customers and deliver significant efficiency in areas like technician routing and sales.”
Offloading business service assets
Even though business services M&A activity has been dominated by private equity firms and trade buyers on the lookout for deals, corporates have also moved to offload business services assets rather than bring them in.
BDO’s head of business services M&A, Satvir Bungar, says business services companies across the board have taken stock of their portfolios through the pandemic.
“They’ve put a sharper focus on their core business and strategy, and there has been a widespread move to divest [themselves of] non-core assets and consolidate cash flows. We’ve seen Viridor exit its Crayford recycling site, and my team worked with LDC portfolio company Retail & Asset Solutions to divest [itself of] its vehicle auditing division, VAS. It’s all about driving value through focus on core business.”
The largest business services deal in 2021 was a carve-out involving France’s state-backed energy company Engie, which sold its energy services business Equans to Bouygues, a group controlled by industrialist Martin Bouygues and his family, in a deal worth more than $8bn.
Engie has undertaken a programme to simplify its sprawling portfolio and wanted to exit Equans, a collection of companies that install refrigeration and heating systems, and work on transport network electrification.
Bouygues had to work hard to win the deal, which had bids from at least seven trade and private equity buyers, according to the Financial Times, including US buy-out firm Bain and French civil engineering construction company Eiffage.
Engie may have been eager to offload the company, which is labour-intensive and has encountered shortages and recruitment challenges, but with dealmakers primed to invest in large business services assets with recurring revenues, the French energy company had no shortage of takers.