LAJ ARTICLES

2015. Professional Services. M&A and the new buyers.

2015 professional services and ma 96

“This is for the soldiers that see the sun at midnight, ya dig” Rick Ross, Free Mason
2015. Professional Services. M&A and the new buyers.
Having been an early investor in many trending and public SaaS and outsourced HR companies, I am approximately qualified to comment about the markets for Professional Services companies.
I include within these walls: Recruiting, PEO, Time and Attendance, Payroll, front end Benefits (client acquisition, underwriting done by carriers such as Zenefits) Accounting, Learning Management Systems, Applicant Tracking and the like.
There are significant distinctions in the revenue streams of the assorted companies/IPO’s. Some are product, others have extended professional service delivery contracts that range from monthly to 1+ years and the differences biz models/org charts that infers.See CONTEXTUAL
And this glimpse into the cynical quality of the author…
Abused as a kid
My childhood on Wall Street has made me flinch at innocent and non threatening gestures.
Where we have been
There was a long bench of companies that were IPO primed since the ‘08/09 financial crises. After that crop hit the market the second wave bobbed to public seas. Now we are several waves in and appetites have not yet been satisfied for SaaS and Enterprise IPO’s.
Where we are now
It is difficult to continue to rationalize rich premiums for cyclical industries that have been repriced as growth.
“If they can get you asking the wrong questions, they don’t have to worry about answers.”  Thomas Pynchon, Gravity’s Rainbow
Good: Investor demand is strong
Good: Companies now have more currency (stock and cash) to spend
Bad (shares are pricing to perfection): Between the incubators, seed and angel funds, accelerators, university funds, seed and a/b financings, VC firms are effectively negotiating and pricing assets amongst themselves.
More bad: Companies are going thru endless rounds of just in time financing and bridge loans giving the ‘last in’ (prior to IPO) inadequate compensation for holding risk
Skipping ahead past a few good things and pet peeves is this: Eager investment in professional services is a recent phenomenon.
These have been cyclical and devilishly difficult companies to understand and had scarce analyst coverage. C.L King, Baird, Robert James, Robinson/SunTrust, Goldman, Dimensional (of which our family office was an investor) and a few scattered brokers with large positions in street name was the whole of the notable coverage and the questions posed on the earnings calls. The stocks were mostly institutionally held and were thinly traded as only a small fraction of the shares were in retail hands.
Ah, the good ole days of wild stock price swings!
These companies are leading indicators of the economy and their shares benefitted from the economic forecast upside and were punished, and shorted, when outlooks were slowed.
Now (2015) there are many papered experts but very few with the patience, endurance and deep understanding to appreciate the difficulties in scaling a complex professional services business. Even fewer can bear the emotional violence of market seismic shifts. Fortunately it’s self correcting, it just takes time and good lessons can be very expensive.
Professional services companies are unique and not lines of code.
Providers must must have frequent, human to human (HTH) interactions with clients and client’s employees – and that’s expensive. Technology self service portals/front end suffers horribly from garbage in/garbage out and the forensics required to remedy have an enormous cost. The amount of human intervention required through-out each process is extra-ordinary. The training needed to get client facing employees is off the charts and a significant forward investment. Retaining tenured staff in each department is difficult and a balancing act. All the pieces of the offering have to fit together and work seamlessly thru pricing, billing reconciling, credit controls, underwriting (if applicable), onboarding, servicing and renewals and other vendors that blend into the offering, that is a lot of opportunity for failures to occur. Oh yeah, then there’s properly pricing and fighting off the competitors. There are also the disparate personalities of developers, sales, marketing, finance, clerical, risk to manage.
“Shortly after we were in bed I began my story, but made it so absurd, so long, and so tiresome, that, as my intention was, I sent her to sleep, and should have gone to sleep myself – but dark plots are ever wakeful. (“The Story of Prince Barkiarokh”)” ― William Beckford, Episodes of Vathek
Where we are going
The big names now have to catch up to their valuations. Tier 1 and premier PE/VC backed market leaders were the earliest and most aggressive to buy the available big books of business to get to a size premium and IPO. The market front runners will be spending the next few years extracting value from recent acquisitions. They are in the ‘improving shareholder value’ phase to regain pricing power, weed unprofitable clients and improve operational leverage.
What remains will be de-fragmented and rolled up with surprising super premium mega size M&A. The largest acquirers are negotiating against well funded industry upstarts and quick windows to get deals done.
Secondary and tertiary market competitors now have the VC/PE and levered top line to pursue assets and the operational infrastructure to improve shareholder returns  from acquisitions.
The prices for high quality, predictable earnings ‘size’ have gone up dramatically in the past few years as there are fewer healthy firms that have size and haven’t already been gobbled up. What remains is expensive and can only be properly synthesized by the companies that have the factories to create value from the purchases.
What’s hot in 2015:
Companies with properly working frontline pieces of sales and marketing
Companies that are deep into the Smartphone
Companies that are bringing on volumes of clients (+/-profitable).
‘Slack like’ companies will rule the world. They bring enormous efficiency to cross selling, and Nir Eyal posted the best commentary I have seen here: http://www.nirandfar.com/2014/11/slack.html
Companies that create more operating leverage or that offer 5x basis point improvement in operations
Companies that can optimize capacity utilization. These are small niches in innovative recruiting, contract creation and pricing, pricing risk toolsets.
What’s not in 2015
“Panic is the sudden realization that everything around you is alive.” William S. Burroughs, Ghost of Chance
API pilfers. beefing up in the watchdogs and enforcement at FB, LI, CRM, Intuit, et al.,
Middle ware services that don’t have levers to extract value and are not differentiated in the market
Companies that don’t have the resources to make strategic (or opportunistic) acquisitions.
Products hogging deskptop real estate and couldn’t compress into a smart phone
Um, it’s a long list and CONTEXTUAL
And this closing note
Moving into the middle to ending months of 2015 VC/PE’s will lose patience and look to find a new home for paper and re-capture some value from their investment. Portfolio cannibalism and the banquet will be crop served to the cream.
“There are two sides to a trade
The market in the long run is an efficient pricing mechanism
Mispricing risk creates opportunities
Momentum investors are always right until they are always wrong” Adam Townsend
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