The last two years brought with it a great deal of merger and acquisition (M&A) activity in the high-tech aftermarket services space. Electronics distribution and services giants Arrow and Avnet used their platforms, know-how and cash to acquire complimentary businesses that are adjacent to their existing service lines. More importantly, small, niche, aftermarket service industry participants continue to become increasingly attractive because of the upside opportunities they present. And acquirers need to identify the winning strategy in positioning their companies with such adjoining business growth.
“Add-on” acquisitions such as Avnet’s acquirement of Round2 Technologies, Pinnacle Data Systems Inc. (PDSi) and Nexicore Services represented opportunities for them to “touch” customers in a different way than they have historically, as well as in a more profitable and less commoditized service offering. They gained specialty services in electronics repair, technical services/call centers and electronic asset disposition (EAD). Additionally, through its acquisition of Tech Turn, Arrow gained specialization in service parts logistics, asset recovery, data destruction and e-cycling. But why are these small, niche aftermarket service industry participants so attractive?
Deploy the right consolidation method
In order to answer this, we must first understand the context of aftermarket services. When referring to the high-tech space, the term “aftermarket services” encompasses the services commonly referred to as technical support; field support; service parts logistics; electronics repair; asset recovery; data destruction; and e-cycling. These service markets have been historically served by specialized providers, each delivering their niche service offering (such as service parts logistics) to a select group of customers.
Typically, their customer density limits are bound by either a specific relationship base or the capital needed to adequately service their customers and keep them coming back. These companies can range in size from $10s of millions in revenue to $100s of millions in revenue (but typically fall between $20 million and $100 million in annual revenue). Due to the fragmentation of their service offerings and a size and geography limitation, this marketplace grew into a sizeable cottage industry with many participants servicing the major brands in the high-tech space. Even more interesting, their gross profit margins can range from approximately 25-to-50-plus percent. These margins are fairly sizeable in an overall industry that considers mid-teens as respectable gross profit margins. Due to these industry characteristics, it’s not hard to see why acquisition-minded participants in this space have been active.
The typical acquirer of these aftermarket services companies is a billions-in-revenue national or multi-national organization. These organizations enjoy gross profit margins in the mid-teens and have typically grown through vertical consolidation methods through which they get bigger revenue numbers but similar financial results on a percentage basis.
What these larger acquirers bring to the table is cash to invest, a global customer base and a platform to service them from. What the aftermarket service company brings to the table is an adjacent revenue opportunity for the acquirer—as opposed to the historical vertical acquisition strategy—that comes with double or triple the gross profit percentage. When you spread that over the thousands of customers the acquirer has relationships with, it adds up quickly in terms of net income and earnings per share.
While that’s really good news, due to the fragmentation of the services marketplace, in order to have a robust offering and realize that potential, one needs to acquire more than a handful of these service providers. And that’s exactly what such large acquirers have been doing. They have been stringing together adjacent and complimentary services to their existing businesses, thus positioning themselves for margin expansion in the longer term—a winning strategy.