Why private equity firms are upping their stakes in the consultancy sector

30 July 2018 Consultancy.uk

Traditionally, consultancy business models have not especially lent themselves to the interests of private investors. They have typically relied on highly-qualified employees undertaking project-based work – a scenario which tends to generate ‘lumpy’ cash flow profiles: not ideal for investors looking for regular income streams. Some strategic acquirers also have concerns around the challenges of integrating people-based businesses and of ‘cashing-out’ major shareholders and fee-generators.

However, these perceptions are rapidly changing, and valuations and deal activity in the sector is starting to flourish. Where previously uncertainty in the market had hindered investor confidence, now the allure of high-quality specialist consultancy assets across the sector, and a recognition and understanding of the impressive returns that many consultancies generate, has acted as a catalyst for growth in M&A activity.

Obviously, the consultancy market covers a wide spectrum of business models, serving a diverse range of end markets and thus demonstrating differing values to investors. Of the key subsectors, digital consultancies are currently the highest rated. These companies boast a strong market sentiment, with gross margins consistently above 30% and are seen to have intrinsic value, enhanced by ‘hot’ areas of interest, such as digitisation, cyber security and managed services. Similarly, professional services consistently trade at high EBITDA multiples, reflecting the high levels of expertise and intellectual property associated with their service delivery.

That being said, technical consultancies have shown strong revenue growth in recent years, off the back of robust automotive and infrastructure markets and a recent recovering oil and gas market. Whilst they have demonstrated strong growth in recent years, human capital resourcing commonly attracts the lowest valuation multiples, reflecting lower margins and ‘value-add’ in their business models.

Why private equity are upping their stakes in the consultancy sector

What are the key value drivers?

There are several characteristics that have heightened investor appetite in the sector. Firstly, consultancies offer a high quality of earnings. Despite the project-based nature of many consultancies, private equity (PE) investors have identified that a clear track record of repeat work with loyal clients can prove attractive as an earnings stream. On top of that, longer-term projects have helped provide better earnings visibility, a fact valued by investors.

Then there is the matter of scale and diversity that consultancies can offer. Greater scale implies less reliance on key clients, and as well, larger consultancies often have evolved talent management and proven business development processes that reduces reliance on key individuals. This diversification of a consultancy’s client base and staff helps mitigate perceived risk in the eyes of investors.

High quality consultancies that have a well-developed knowhow, and solutions that can be easily implemented across multiple clients and enhance margins can also drive considerable value. Where these capabilities are underpinned by bespoke software and technology platforms, it will attract a meaningful premium.

In addition, strategic investors and acquirers will be keen to know what they are buying into in terms of key ‘assets’ in the business. Fundamentally, consultancies are people businesses, so a strong base of directly employed consultants will benefit a firm’s worth, whereas an excessive reliance on a self-employed base of ‘associate’ consultants can have the opposite effect.

Lastly, any scope for international expansion has become an increasingly attractive proposition, as it reduces vulnerability to localised economic cycles and allows opportunities for companies to service larger, international clients.

What trends are apparent in deal activity?

Recent high-profile deals illustrate the scale of interest that the consultancy sector is generating in terms of international investment. Trends show that the financial services consulting sector attracts the most private sector attention and there is a particular focus on the pursuit of opportunities that allow for a buy-and-build type strategy. A recent notable example is Permira’s investment in Duff & Phelps for $1.75 billion in late-2017 who in turn acquired risk consultancy Kroll in March this year.

“The consulting industry has enjoyed a surge in deal activity by private equity firms in recent years.”
– Alex John, Partner at Livingstone

Numerous sector specialists have taken the stance that they are better off under private equity ownership, as illustrated by Clayton, Dubilier & Rice’s £367 million investment in financial services specialist Capco in May 2017, acquiring majority control from technology firm FIS. Looking at the wider consulting sector, private equity investment at the mid-market level is significant, generating substantial returns. Example deals include, Graphite Capital’s acquisition of leadership consultancy YSC, generating a 2.4x return for Livingbridge and HgCapital’s investment in Citation.

What’s becoming evident is that previous assumptions about the consultancy industry’s unsuitability for private equity investment have been well and truly disproved. The reality is that the sector has enjoyed a huge surge in deal activity, demonstrating an increasing appetite for investment as well as opportunities for future growth. Fundamentally, this is down to investors acknowledging the high quality of consultancy businesses, as well as understanding the key drivers of value: the prevalence of specialist knowledge, loyal client bases, strong HR infrastructures and opportunities for international expansion. This increased interest will invigorate the sector, stimulating deal activity and powering future development.

An article from Alex John, a Partner in Livingstone's Business Services practice. He has advised on and led over 40 completed transactions since joining the mid-market M&A firm a decade ago.


Private equity firms ramp up sustainability focus

19 April 2019 Consultancy.uk

In line with business leaders across the industrial gamut, private equity firms are increasingly on board with sustainability projects. According to a new study, the investment arms for major funds are implementing a number of strategies aimed at supporting sustainable economic development in line with global goals.

While the business world has finally begun to acknowledge the danger of climate change, effective action plans remain difficult to achieve. The Paris Agreement has stipulated a clear target for the decades leading up to 2100, although massively reducing emissions while not crashing the economy could be a tall order.

Businesses that are able to acquire capital can use it to boost productivity and output, thereby creating a virtuous cycle of development. However, some businesses are better able to utilise resources than others, both in terms of their relative productivity, as well as the value of the respective outcomes relative to costs (including environmental harms). Financing can therefore provide an avenue to select businesses that are aligned with various global sustainability goals, while shunning those that drive little or unsustainable social value creation.

Top moves made by investment arms towards responsible investment

Profit has for the longest time been the central criterion for investment decisions. Yet profit at any cost is increasingly seen as creating considerable social harms, while often delivering only marginal value. As a result, the private equity sector, which was initially sluggish to change its ways with regards to sustainability, has started to see the topic as an opportunity as much as a challenge.

A new study from PwC has explored how far sustainability goals have become part of the wider investment strategy for private equity (PE) firms. The report is based on analysis of a survey of 162 firms and includes responses from 145 general partners and 38 limited partners.

Maturing sustainability

Top-line results show that responsible investment has become an issue for 91% of respondents. For 81% of respondents, ESG (environmental, social, and corporate governance) was a board matter at least once a year, while 60% said that they already have implemented measures to address human rights issues. Two-thirds have identified and prioritised Sustainable Development goals that are relevant to their investment segments.

Change in concern and action on climate-related topics over time

While there is increasing concern around key issues, from human rights protections to environmental and biodiversity protection, the study finds there are mismatches between concern and action. For instance, concern among investment vehicles around climate change has increased since 2016.

In terms of risks to the PE firm itself, concern has increased from 46% of respondents in 2016 to 58% in the latest survey. However, the number who have taken action remains far below those concerned, at 9% in 2016 and 20% in 2019. Given the relatively broader scope of investment opportunities, portfolio companies face higher risks – and more concern – from PE professionals, at 83% in the latest survey. However, action is less than half of those concerned, at 31%.

Changing climate

In terms of the climate footprint of the portfolio companies, 77% of respondents state concern in the latest survey. 28% of respondents are taking action through the implementation of measures to mitigate their concerns.

Concern and action taken on ESG issues

In terms of the more pressing issues for emerging responsible investment or ESG issues, governance concern of portfolio companies comes in at number one (92% of respondents), while 60% have taken action on it. Firms have focused on improving awareness – setting up policies and a range of training modules for their professionals around responsible investment decision making. Cybersecurity takes the number two spot, with 89% concerned and 41% implementing strategies to mitigate risks.

Climate risks take the number three spot in terms of concern for portfolio companies (83%), but falls behind in terms of action (31%). Health and safety track records are a key concern at 80% of businesses, with 49% implementing action. Gender imbalance within PE firms themselves ranks at 78%, which is being dealt with by 31%. A recent survey from Oliver Wyman showed that there is gender balance at 13% of GP teams in developed countries.

Biodiversity is also an increasingly pertinent topic, with risks from pollution and chemical use increasingly driving wider systematic risks around environmental outcomes. It featured at number eight on the ranking of most likely global risks for the coming decade, with its impact at number six. As it stands, biodiversity is noted as an issue at 57% of firms, with 15% implementing action.