- February 22, 2016
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MSPs Generate Highest Stock Value Increase Over Five Year Period, According to Service Leadership Index®
The Service Leadership Index® objectively categorizes all IT Solution Providers into one of 10 Predominant Business Models© in order to most accurately benchmark their financial performance, stock value creation and most applicable best practices. The S-L Index™ is the largest and most accurate ongoing financial and operational benchmark of Solution Providers worldwide.
In this blog, Service Leadership provides SolarWinds N-able partners with an exclusive preview of some of the results reported in the soon-to-be released 2016 Annual Solution Provider Industry Profitability Report© as well as insight into what will be covered in our March 3 webinar, “Advanced Value Creation Strategies for SMB and Mid-Market MSPs.”
The chart below shows the five-year value creation trend of the average SMB/Mid-Market Managed Service Provider (in S-L Index™ terminology, Infrastructure-Managed Services-Centric companies) over the past five years.
(click on image to expand)
This subset of dataset is comprised only of SMB/Mid-Market MSPs that benchmarked with the S-L Index all years of the five-year period, so the growth seen above is not impacted by the addition or subtraction of companies within the five-year period. In summary:
- Top line revenue (blue bars) grew from $3.03mm in 2011 to $4.26mm in 2015, a Compound Annual Growth Rate (CAGR) of 7.0%.
- Within that, growth of MSP-delivered recurring revenue dollars (Managed Services and private cloud services, shown in the gold line as a percent of revenue) grew at a 12.3% CAGR.
- Since overall CAGR at 7.0% was less than recurring revenue CAGR, it means that product resale (including cloud resale) grew more slowly. In fact, it grew at 2.7% CAGR.
- However, within that product resale growth is cloud resale which, although still very small in dollar terms, grew at a CAGR of 194.8% over the five years. During that time, in terms of share of the average SMB MSP’s total revenue, cloud resale went from negligible in 2011 to 2.0% of total revenue in 2015. Obviously this is growing quickly, as very small share numbers can do, but it will be some time before cloud resale revenue – much less it’s margin – has a material impact on the average SMB MSP’s income statement.
- Adjusted EBITDA (i.e. bottom line profit after owner fair market compensation) performance (green bars and green line) improved from 6.8% of revenue in 2011 to 8.2% in 2015. Combined with revenue growth, this increased efficiency at generating profit dollars resulted in a 9.3% CAGR in EBITDA dollars (green bar).
The “Approximate Company Value” number (black line) is an average of two value approximations:
- One is the approximate EBITDA valuation, that is, Adjusted EBITDA dollars times a market multiple for the year in question. The market multiple that we (Service Leadership) use for a given year, is set by us based on our exposure to M&A deal flow within that year including valuations we have performed. Over the past five years, the EBITDA multiples for SMB MSPs has drifted upwards to about 6.75x in 2015 (though our model varies this by EBITDA % performance as well). We expect this multiple to hold in 2016, barring any macro-economic events.
- The other is the approximate revenue valuation, that is, the revenue for each line of business individually, times a market multiple we establish for each line of business, again based on our exposure to the M&A marketplace for that year. Product resale revenue has remained roughly flat for a number of years, at about $0.10 in value for every dollar or product resale revenue. The line of business with the highest revenue multiple is Managed Services, which in 2015 repeated the 2014 multiple of $1.275 dollars of value for each revenue dollar. We expect this to continue in 2016, again barring any macro-economic events.
- These two approximate valuations are averaged together to calculate the “Approximate Company Value” shown in the black line on the chart.
We’ll stress here that these multiples are approximates. When we perform formal valuations, we integrate more precise forms of these multiples along with a number of other dimensions. That said, of course, the value of an asset can only be established with certainty at the point a transaction takes place. The title of this blog indicates that MSPs have in fact driven this Approximate Company Valuation line higher than other IT Solution Provider business models.
As noted above, the Service Leadership Index objectively categorizes all Solution Providers into 10 Predominant Business Models. Just as we track the performance and approximate valuation of MSPs as above, we track the other nine. Of the 10 Predominant Business Models into which all Solution Providers fall, the Managed Services-centric business model, as we have seen, generated a 22.3% CAGR in Approximate Company Value between 2011 and 2015. The Predominant Business Model which delivered the highest increase in Approximate Company Value over the five-year period was Product-Centric partners (that is, objectively, those Solution Providers who had at least 60% of their top line revenue from things they resell, not services they provide themselves).
These Product-Centric companies delivered a slightly higher growth in approximate valuation than did the MSPs (24.6% CAGR vs. 22.3% CAGR) but that growth is largely due to very low valuation performance in 2011. If we look at the increase in Approximate Company Value from a solid base, the MSP business model has delivered very well over the past five years. Barring macro-economic events outside the control of those in the industry, we do not see any trends (included purported, but not factual “erosion” from cloud or Managed Service “commoditization”) that would be an obstacle to MSPs continuing this value creation growth.
We will therefore confidently state that the MSP business model has delivered the highest value creation performance over the past five years of all 10 Solution Provider Predominant Business Models. It may be worth noting that those Solution Providers still in the break/fix model – the business model from which many current MSPs have evolved – delivered value creation of only 2.6% CAGR over the five years, as compared to the MSPs delivering 22.3% CAGR. This is of course a strong validation of the decision to leave the break/fix model and pursue becoming an MSP. These are for the average companies in the business models.
In the upcoming webcast, “Advanced Value Creation Strategies for SMB and Mid-Market MSPs,” we’ll springboard off this blog by discussing what the top performing SMB and mid-market MSPs are doing to drive value creation even farther. Register now for the webinar — spots are filling up quickly.
ABOUT SERVICE LEADERSHIP, INC.
Service Leadership is dedicated to providing total profit solutions for IT Solution Providers, directly and through industry consultants and global IT vendors. The company publishes the leading vendor-neutral, Solution Provider financial and operational benchmark: Service Leadership Index®. This includes private diagnostic benchmarks for individual Solution Providers and their business coaches and consultants. The company also publishes SLIQ©, the exclusive web application for partner owners and executives to drive financial improvements by confidentially assessing and driving their Operational Maturity Level©. Service Leadership offers advanced peer groups for Solution Providers of all sizes and business models, and individual management consulting engagements for Solution Providers from US$15mm to US$3bb in size worldwide. In addition, Service Leadership provides global IT vendors with advanced partner enablement assets, partner ROI models, management consulting and advanced peer groups, as well as executive and industry best practices education and speaking. Please visit www.service-leadership.com for more information.
Notice: The terms and concepts of SLIQ©, Service Leadership Index®, (S-L Index™), Predominant Business Model© (PBM©), Operational Maturity Level© (OML©), Normalized Solution Provider Charts of Accounts© (NSPCoA©), Total Cost of Managed Services© (TCMS©) and Service Factory© are proprietary to Service Leadership, Inc. All Rights Reserved.