This latest deal was the 12th investment made by Evergreen in 2018.
Bay Area investor Evergreen Services Group recently purchased NetGain Technologies, a longtime member of the MSP 501. This month’s deal was the 12th investment made by Evergreen this year.
Previously, the San Francisco-based investment company made investments in Wolf Consulting, Executech, Jenlor, Interlaced, and Integritek. Since making closing these deals, Evergreen companies have gone on to make additional ones. In early December, Executech announced its acquisition of Z7 Networks, a Seattle-based MSP. The deal gives Executech, a Rocky Mountain-area powerhouse based in South Jordan, Utah, a foothold in the fast-growing Pacific Northwest region.
This is precisely what Evergreen has envisioned — a catalog of strategically position, regionally based MSPs.
For perspectives on Evergreen’s strategy, as well as prevailing market trends, Channel Futures reached out to Ramsey Sahyoun, head of mergers and acquisitions at Evergreen, whose distinct investment strategy is helping to redefine the MSP market. In interviews with Sahyoun and Jason Jacobson, CEO of NetGain of Lexington, Kentucky, we gather insights on the direction of Evergreen, the allure of recurring revenue and the qualities that attract outside investment.
We start with Sahyoun, who met his business partner, Evergreen CEO Jeff Totten, while working at Alpine Investors in San Francisco. Alpine specializes in software companies and B2B services, in particular. After some time at Alpine, Totten and Sahyoun saw an opportunity to establish a distinct position in rapidly expanding market for managed services. They persuaded Alpine to create a new fund – the company’s sixth – focused on MSPs. Unlike traditional funds, Evergreen invests in companies for the long haul. Thirty-six-month payouts? Evergreen knew that wasn’t going to happen with MSPs.
“We wanted to build a permanent holding company,” says Sahyoun. The inspiration for calling the company “Evergreen” came to him after attending a Berkshire-Hathaway Inc. annual meeting in Omaha, where the virtues of predictable, monthly recurring customer revenue (MRR) were praised time and again.
While at Alpine, Sahyoun and Totten saw the market for technology services shift from project-based work paid for with capital investment dollars to cloud-based digital services paid with operating expense funds. The seismic shift to more predictable, scalable and profitable revenue streams particularly grabbed their attention. When Sahyoun and Totten realized that the economics of most SMBs would never allow these small businesses to afford top technology talent to help them achieve their business aims, they began to see a long runway for MSPs that could.
Evergreen estimates that there is roughly $10 billion in managed-services revenue generated among SMBs every year in the U.S. While some big companies, including All Covered and Sirius, which was ranked No. 1 in the 2018 MSP 501 study, have established leadership positions, the majority of business done in the SMB space is captured by roughly 20,000 or so small, independent players.
Evergreen’s hunch was that more of the total market spend could be captured by a set of very capable regional players who maintained a high degree of customer intimacy and who had the ability to implement best practices and scale more efficiently.
After some research, Evergreen’s hunches were confirmed. Whereas most MSPs were growing at a rate of around 9 percent annually, larger, more capable ones were increasing their annual sales at a rate of 15-20 percent.
“If I had to summarize what we saw it was this: a shift toward recurring revenue, the size and fragmentation of the industry and the ability of somewhat larger players to outperform their peers, and an unending value proposition for millions of end customers,” says Sahyoun.
Upside Aplenty, But Challenges Too
In any investment you make, there are going to be risks, says Sahyoun. There are existential and risks and real-time downsides, he adds.
In the near term, the cost of talent acquisition is holding back a number of growing MSPs. Long-term challenges, including AI or vendor plans to offer desktop-as-a-service threaten MSPs. But for now, Sahyoun thinks MSPs are great investment opportunities.
What sets Evergreen apart, in addition to building a permanent home for its MSP investments, is its preference for regional providers. Six of the 13 acquisitions that Evergreen has made are “platform” providers in that they operate independently within their own regions. They grow their businesses both organically and via acquisition.
“We are not creating a single, national platform like what some other folks have tried to do,” says Sahyoun. That decision was inspired by Evergreen’s parent, Alpine, which made a series of successful investments in regional HVAC and plumbing service providers that had strong local brands and excellent geographic penetration. Forcing them to adopt one national brand or one set of go-to-market processes would not have been the right way to go, Sahyoun says.
“Our thesis is, we want to have 10 – but no more than 10 – different platforms, spread geographically across the United States. There may be a play in a given vertical (we already have an investment into an Apple-focused MSP that is national) but by and large we want regional platforms and build each of those businesses to be really big,” says Sahyoun.
With that as a model, Evergreen continues to look for potential investments. One of those that it found that fits its philosophy is NetGain.
Founded in 1984, NetGain “monitors, manages and maintains the systems and networks that support 10,000 computer users across the region.” The Kentucky-based company provides managed services from a state-of-the-art network operations center that is backed by 85 engineers and technicians who hold 250 technical certifications. In addition to Kentucky, NetGain has offices in Chattanooga, Tennessee; St. Louis; Little Rock, Arkansas; and Cincinnati.
When Evergreen came calling, NetGain executives liked what they heard.
“There will always be some companies that are small. And there will always be companies trying to do what Office Depot is trying to do. What I do think is going to keep happening is this consolidation somewhere in the middle,” says NetGain CEO Jacobson. “What I am seeing after talking to private equity groups, including our new investor Evergreen, is few investors are interested in trying to create the next national player. I find that interesting. They really are not trying to create a national presence. I have heard from three private equity groups – and I won’t name names – who believe that past attempts to do just that have not panned out that well. So, they [and others] are looking to build things and keep them to a regional standpoint.”
For its case, Evergreen looks for companies that generate at least half of their sales from MRR. (In fact, 65 percent of the sales that Evergreen companies generate comes from MRR lines of business, collectively.) Evergreen also evaluates companies on a variety of other factors, including new customer acquisition, employee retention, management tenure and ambition, and, of course, cash flow, typically calculated by EBITDA.
“The M&A market has been hot for a long time. Obviously, evaluations are high and there’s a lot of money in private equity chasing the same companies. That dynamic probably cannot last forever. I would expect in 2019 or sometime thereafter for a slowdown in deals and a decrease in evaluations. The other thing I would appeal to people to keep an eye on is interest rates,” says Sahyoun. “The ability to borrow money at a low interest is a big part of what is driving M&A activity.”
If interest rates continue to rise, expect the pace of M&A activity to slow. The same is likely true if the stock market continues to churn as it has in the past few months.