The MSP software market is experiencing seismic shifts with vendors and distributors vying to be the one-stop-shop of choice for MSPs. Robin Ody, Principle Analyst at Canalys gives his take on what's we can expect to happen with valuations moving forward.
How is the MSP market growing, and what metrics can we use to determine the value of an investment?
Canalys estimates the IT managed services market was worth approximately US$488bn in 2023 and is estimated to grow at least 12% in 2024. This is revenue generated by channel partners for the managed services they deliver to their business customers, not made by reselling products from IT vendors. Approximately, 13% of those partners were MSPs (making more than 50% of their revenue from managed services), with another 13% making between 30% ad 50% of revenue from managed services. That leaves nearly three-quarters of the managed services channel operating primarily resell, consultancy, telco or systems integrator models.
Why does this matter? These figures have a direct impact on many areas, from the way an IT vendor builds an MSP partner program to the value private equity firms put on the companies they acquire and in which they invest. As the managed services market evolves it is time to reassess what we think we know about the channel’s value, vendors, and the money flowing through these channels.
Private equity and the (re-e)valuation of the vendor landscape
Kaseya acquired Datto in April 2022 for US$6.2bn, funded by a consortium of companies led by Kaseya’s private equity owner Insight Partners (which also owns Veeam and many other technology firms globally), along with TPG and Temasek.
This was around 10X revenue, which in the previous year had been US$618.7m, with year-on-year growth of 21%. It made around 62% of that revenue from its backup portfolio, with the rest coming from PSA (Autotask), RMM, and some other products like cybersecurity. Its net profit for 2021 was US$51.4m, which grew 129% from the previous year.
Was that price too high or not high enough? Private equity and venture capital investors have several ways of valuing a company for M&A, but what is not in doubt is how valuable Datto was to its MSP partners, of which it had around 20,000 at the time of its acquisition.
The key things to look at in this deal are brand image, market share, product roadmap, and the dynamics of the customer landscape in which the two operated. Both companies provide RMM, PSA, backup, and some cybersecurity products or services. But Datto had much more credibility among MSPs, and its products were well-regarded. Its brand image was much stronger than Kaseya’s. But the two had approximately equal market share in the RMM and PSA landscape, while the backup revenue brought a good mix of resell partner motion to the overall product portfolio.
Ironically, it was this on-premises, hardware-related revenue which put off other investors at the eventual price per share which Datto sold for, because those investors felt it could easily be replaced by cloud infrastructure vendors This has not transpired and is unlikely to be the case for some time, certainly not within the average 5-to-8-year timeframe which PE investors hold their investments for. And yet having a mix of products which allow partners to generate both resell and managed services revenue is very compelling and makes the company’s addressable market much larger. Remember, RMM and PSA tools are mostly a sell-to motion, meaning they are sold to MSPs and not through them in the way backup technology can be, and investors sometimes see this as a barrier to growth and TAM (inaccurately in my opinion, but I understand the view).
This is where we turn to market dynamics. The MSP market is a difficult one to crack. MSPs are on the whole small companies which do not have a lot of money to invest in managing multiple vendor relationships and certified technical staff. There are not that many vendors which combine relatively easy-to-use and deploy products and good technical support, at a price which allows those MSPs to build in margin to their service packages (though, there are many who claim to do so).
Equally, for those companies which sell managed services but are primarily resellers or systems integrators, they want to work with vendors which fit their model and understand their hybrid approach. If we go back to the three quarters of the managed services channel which is not operating like an MSP, buying a vendor which can bridge those worlds is incredibly valuable. And that is not considering the growth in new partners which will be formed over the next three to five years, many of whom will be looking to operate in this hybrid model.
The final point here is the product and market roadmap. 2024 is the year of the platform (among many other things) and more vendors are trying to keep their partners within their own ecosystems. In some cases, they are deciding to focus on in-house capability and integration between products. If you are a vendor like ConnectWise or Kaseya it makes sense to try capture much greater wallet share in your markets by building platforms which deliver the five primary products partners use for their managed services (RMM, PSA, backup, cybersecurity, and cloud), while others are trying to build ecosystems by investing in third-party integrations.
Overall, it will probably be seen as a good deal, and though the price may have seemed 15-20% too high for some, it is easy to see how investors will start to look at more metrics when placing their best in the MSP market, at both the vendor and partner levels. Of course, it still needs to be executed, and there will almost certainly be many more acquisitions by these companies in the coming years. It is possible that at least one of these companies makes a sizeable acquisition this year to try to expand that platform strategy. I am sure the price of any such deal will also be scrutinized, but we can do so through fresh eyes and perhaps come up with a different conclusion.