Infrastructure software: where's the market going?

2021 has seen a wave of deals so far in the infrastructure software space. Andy Morgan and Gareth Davies explain why there's been so much interest and how the industry might look by the end of 2021.

Notable deals

• Darktrace (security orchestration and automated response) listed on the LSE at an enterprise value of £2.2 billion
• ITRS (application monitoring) completed a secondary transaction with Montagu at an enterprise value of £400 million, and has continued to accelerate its growth through the subsequent acquisition of Opsview
• Snyk raised USD $300 million, valuing the business at USD $4.7 billion – sharply up on its valuation from a previous funding round six months before
• Carlyle acquired a majority stake in 1E (endpoint management software) for an estimated £190 million enterprise value
• Jamf acquired Wandera (iOS- and Android-focused endpoint protection) for an estimated £280 million enterprise value

Elevated interest in infrastructure software M&A

_{Figure 1: UK infrastructure software transaction volume and value by deal type. Source: Megabuyte.}

There has been something of a historic perception that infrastructure, security and related areas such as development tools are much less glamorous than other fields in B2B software. Infrastructure software was historically characterised by lower levels of subscription revenue, higher levels of technical debt, longer sales cycles and lower revenue growth.

The last few years have seen a real sea-change. Lockdown and the rise of remote working have highlighted the defensive qualities of the sector. Infrastructure software is at the heart of cyber resilience, enabling remote working and the essential applications we now rely on, such as Teams, Slack and the whole array of unified comms.

The sector has also raised its game in terms of earnings quality. Levels of recurring revenue and upsell are higher than a few years ago, churn is down, and there is less dependency on revenue from service and maintenance.

This has created a double whammy of growing investor interest in the sector alongside higher deal multiples. The best assets are transacting at mid-to-high single-digit multiples of revenue, depending on the sector. Public investors have also grown to appreciate the qualities of infrastructure software assets.

M&A transaction environment for infrastructure software looks robust

_{Figure 2: Distribution of EV/revenue multiples within recent M&A transactions in infrastructure software. Source: Mergermarket, Megabuyte, Capital IQ, Grant Thornton analysis.}

Public infrastructure software equities have re-rated

_{Figure 3: Infrastructure software quotes comparables by subsector. Source: Capital IQ.}

Of the three segments that make up infrastructure software, cyber security is probably the most high profile. Early 2021 saw ransomware affect areas as diverse as energy (eg, the Colonial Pipeline attack) and health (eg, impact on the Republic of Ireland’s health service), which highlights just how critical robust and resilient cyber security solutions have become.

Ultimately, the result of these high-profile events will be to move security even further up the board agenda. The industry has always struggled with the reactive nature of buyers.

We saw the same thing in 2017. WannaCry was a big wake-up call for government and industry in the UK, and investment sharply increased in the years that followed.

That’s not to say that there’s less going on in other segments of the infrastructure software market. In 2020, organisations had to ‘sprint’ to enable large-scale remote working. But once the adrenaline rush was over, this just highlighted a plethora of key considerations around dependency on ageing and on-premise technology, device management, endpoint security and even just re-evaluating day-to-day support processes.

There has been significant investment in infrastructure software to make systems fit for purpose. Much of this was on the agenda anyway, but has been brought forward.

Looking ahead

One of the key dynamics we see in the sector is convergence. Once upon a time, developers wrote code and IT professionals managed ‘big iron’ mainframe systems. The two groups didn’t really meet or interact. The industry has massively changed in the last 20 years to embrace agile methodologies, shorter development timelines and more agile release schedules.

Selling to large corporations has changed too. There are fewer decision-makers and these naturally gravitate towards vendors that can provide a ‘one-stop shop'.

The largest vendors have woken up to the commercial opportunities this offers, but even the largest providers can’t do everything themselves. They've turned to M&A to in-fill strategic capabilities that they can’t possibly develop themselves. Trade acquirers play an outsized role in this market and articulating the opportunity around revenue synergies is key.

On the flip side, lots of entrepreneurs want to be the consolidator rather than the consolidated. It's likely we will see a steady stream of IPO activity for assets of scale as shareholders seek to crystallise some of their business value but also access lower-cost capital to build the sector leaders of the future.

In terms of capabilities, areas like logging, synthetic monitoring, containerisation and identity will remain ‘hot’. The UK has a fair number of companies at the bleeding edge of infrastructure software.

As an example, CrowdStrike’s acquisition of UK based Humio in Q1 2021 served to expand CrowdStrike’s footprint further outside of traditional cyber security. We suspect to see more of these kinds of interesting trade acquisitions, funded by both public market capital and private equity, as the larger players look to extend capability and geographic reach into 2022 and beyond.

To discuss deals within the infrastructure software sector further, contact Andy Morgan.