Time to buy into UK services sector?

The strong performance of businesses in the UK’s service industries has provided one of the clearest signs yet that the UK economy is heading in the right direction. With growing confidence that the economy could be turning a corner, the services sector provides a compelling option for M&A buyers seeking to make high-growth acquisitions.

According to S&P Global’s UK Services Purchasing Managers’ Index (PMI) report for April 2024, companies in the UK services industries saw a significant upturn in activity compared to the previous month, with respondents citing a boost in sales resulting from growing client confidence and signs of underlying economic conditions improving.

April recorded a seasonally adjusted S&P Global UK Services PMI Business Activity Index score of 55.0, up from 53.1 in March 2024. This was the fastest rate of activity growth recorded since May 2023 and the sixth consecutive month in which the reading was above the 50.0 no-change value.

Tim Moore, Economics Director at S&P Global Market Intelligence, commented on the findings: “The latest survey results are consistent with the UK economy growing at a quarterly rate of 0.4 per cent and therefore pulling further out of last year's shallow recession. Relief at a turnaround in the economic outlook was commonly cited as a factor supporting sales pipelines in April.”

Of course, these are only early indications of a recovery and businesses across the UK still face an array of headwinds that are likely to persist for months to come. Even if there is a concerted economic upturn, there will be a significant lag before this is felt by struggling businesses.

This ongoing uncertainty was demonstrated by S&P noting that, despite the improvements seen during April, services sector companies still saw the sharpest increase in input costs since August 2023, while employment figures saw their smallest increase in the past four months, with S&P saying that constrained margins meant businesses seemed more cautious about hiring.

What does the UK Services PMI measure?
Broadly speaking, the services sector comprises businesses that provide either business-to-business (B2B) or business-to-consumer (B2C) services. In S&P’s PMI reports, the services sector covers industries including consumer (excluding retail), transport, information, finance, insurance, communication, real estate and business services.

The PMI report polls approximately 650 companies across these sectors, stratified by sector and company workforce size and based on contributions to GDP. The survey collects responses during the second half of each month to gauge the direction of change in comparison to the previous month.

A diffusion index is then calculated for variations between the surveys, with the index being the sum of the percentage of “higher” responses compared to the previous month and half the percentage of responses that showed no change. The index runs from 0 to 100, with an index score above 50 indicating an overall increase compared to the previous month and a score below 50 representing a decrease.

The survey’s headline figure is the Services Business Activity Index, which is calculated by asking for changes in business activity volume compared to the previous month. Indices within the report are also seasonally adjusted.

Signs of improvement
While there were significant areas in which the report demonstrated the ongoing fragility of the UK economy, the headline takeaway was the sense of optimism that conditions are improving for businesses in the services sector – which, along with manufacturing, is one of the UK’s most vital industries.

The most important finding was the near-one-year-high Business Activity Index of 55.0, demonstrating that business activity volume has increased considerably from the 53.1 figure seen in March 2024.

New order volumes were at their highest level in 11 months, with S&P saying that respondents had “noted that sales pipelines had improved amid stronger business and consumer spending, in part linked to greater optimism towards the broader economic outlook.”

The report also stated that higher levels of new work had also boosted order books, showing the fastest growth since March 2023. S&P stated that this index came amid consistent reports that sales to clients in the US and Asia were strengthening.

Despite the uptick in new order intakes, the survey also showed that there had been a slight fall in work backlogs, with respondents typically saying that their business capacity was sufficient to deal with new and existing workloads.

The report also found that sentiment among service providers for their business activity prospects in the year ahead was upbeat. 54 per cent of survey respondents anticipated an increase in business activity over the next year, compared to just 10 per cent who predicted a decline.

While this was down from the two-year peak in optimism recorded in February’s index, it still demonstrated that a significant proportion of service firms are positive about the future, with respondents citing signs of improving client demand, rising business investment, long-term expansion plans and forthcoming marketing initiatives.

The dealmaking perspective
With the services sector providing early indications of an upturn in the UK’s economic fortunes, it would make sense for M&A buyers to target acquisitions in this wide-ranging industry – particularly buyers who are looking beyond distressed deals to acquisitions that will drive rapid growth during an economic recovery.

Even amid the generally slow dealmaking activity that the UK has seen over the past two years, some areas of the service sector have demonstrated significant resilience in terms of M&A.

Some industries, such as insurance, have seen high levels of activity as a result of ongoing fragmentation and the ability for consolidators to rapidly build scale through acquisitions. Sectors, such as communications, have experienced strong M&A due to high levels of investment in emerging areas of infrastructure. Others, like hospitality, have seen a high level of distressed M&A.

Should the UK economy see concerted growth over the coming months and the M&A market follow suit, it is almost certain that service sector businesses will play a major part in this, both as acquirers and as acquisition targets.

Accommodation – Hotel industry poised for rebound



The UK hotel industry has been badly affected by the ongoing effects of Brexit and COVID-19, as well as, more recently, soaring costs for labour, energy and food and drinks. This has resulted in high levels of insolvency, as well as a significant amount of distressed dealmaking.

In a recent report, UHY Hacker Young revealed that hotel company insolvencies stood at 151 in 2023-24, up by 19 per cent 127 insolvencies in 2022/23. The report noted that hotels particularly suffered last year as a result of rising costs, amid high interest rates and inflation, which they have been unable to pass on to customers.

The slump in staff coming into the UK from Europe post-Brexit – a major source of labour for the industry – has reportedly led to the hotel sector seeing the highest rate of wage inflation out of all UK sectors, with an increase of 53 per cent over the last decade.

Another factor that has had a major impact on the sector is the decline in business travel since the COVID-19 pandemic. Business travel is a crucial source of revenue for many hotel operators, particularly those in large urban areas, but there has been a significant reduction in business events such as corporate away days and conferences since the pandemic.

There has also been a significant reduction in tourism to the UK since COVID-19, with UHY Hacker Young reporting that approximately 10.9 million international tourists visited the UK during Q3 2023, an 8 per cent drop from the figure seen in the corresponding quarter in 2019 – shortly before the onset of COVID-19.

However, there have been strong indications that business travel could see a concerted recovery during 2024, with 67 per cent of respondents to the Global Business Travel Association’s (GBTA) most recent Business Travel Outlook saying that they expected to increase their business travel this year compared to 2023, while 59 per cent expected to make more business trips.

The GBTA report largely attributed this to business travellers no longer seeing COVID-19 as a significant barrier, something that should also contribute to increasing international tourist travel. However, another vital factor will be the state of the UK economy.

Should inflation continue to fall, the chances of the Bank of England finally making an interest rate cut will increase. At the start of this year, property specialists Christie & Co identified pressure on household incomes as a key challenge for the industry, writing that cost pressures “will drive guests towards the value-for-money accommodation offering”.

With high-end luxury hotels continuing to perform strongly, Christie & Co forecast that this could lead to “further polarisation of the market towards economy and luxury segments with a squeezed midscale segment”.

The UK’s economic state has improved considerably since that report was published in January 2024, but the challenges of high costs and weak consumer confidence still remain. In light of this, mid-market hotel operators will be hoping that an interest rate cut arrives in time for the all-important summer holiday season.

Despite these challenges, M&A activity in the UK hotel sector has largely remained resilient, with strong investor demand for hotels even when the country’s economic woes were at their worst during 2023.

Of course, much of this was driven by distressed M&A, as opportunistic buyers pounced on small and mid-sized struggling operations in attractive areas. In their early year report, Christie & Co forecast this to continue, saying they expected a “notable increase in distress both through consensual and forced sales”.

This is to be expected, given the lag between the early signs of economic recovery and the effects of this being felt by struggling businesses laden with high levels of debt and increasing input costs, and it is certain that there will continue to be a high level both of insolvencies and distressed M&A in the hotel industry.

Hotels will perhaps be most impacted by one of the major challenges identified in the S&P report – rising input costs. Having already been majorly hit by wage inflation over the past decade, hotels struggling to turn a profit while maintaining a strong workforce face another hike after the National Minimum Wage was increased by £1.02 to £11.44 per hour from April 1 2024.

However, signs of an economic recovery also point to the potential for a growing amount of non-distressed M&A, as buyers targeting solvent businesses begin to ramp up their M&A strategies and owners of successful operations begin to feel more confident of securing strong valuations for their businesses.

As has been noted elsewhere, the minimum wage increase may also turn out to be a positive for some hotel operators as a result of the boost to household spending it will deliver for many. If this is combined with an interest rate cut in the summer then hotels may benefit from a significant upsurge in consumer confidence in the second half of the year, particularly after such a long period in which people have had to reduce their discretionary spending and avoid expensive luxuries such as holidays.

Insurance – Consolidation continues
The insurance industry is a key part of the services sector and has been one of several UK industries in which M&A activity has continued to occur at a rapid pace in spite of the economic turmoil of the past two years.

Across Europe, the insurance industry has seen incredibly busy dealmaking activity over recent years, something that has been spurred on, in particular, by a high level of consolidation among insurance brokers.

The European brokerage segment remains highly fragmented, with a huge number of small to mid-size local and regional operators, and often with ageing owners.

This means that there are plenty of opportunities for larger parties to build scale and geographic presence through acquisitions of such firms, particularly as smaller operators come under growing pressure from tightening regulations and growing client expectations. This has enabled consolidators, such as private equity-backed firms and, increasingly, US insurance companies, to undertake expansive M&A drives.

Brokers have been particularly attractive, not only due to fragmentation, but also because they have high profit margins, solid client retention and often a strong history of consistent revenue, even amid market volatility.

This makes the insurance sector a natural place to look at when considering how the growth of the services sector could contribute to a broader M&A recovery – particularly as dealmaking has remained so strong even during the UK’s economic downturn.

The only bugbear is the growing concern that M&A in the UK insurance market may have peaked, with consolidation far more developed in the UK than other European markets following years of intense activity.

In a recent report, MarshBerry highlighted that, while the UK still led the way in Europe in terms of insurance deal volume, the size of deals has decreased – an indication that, while acquisitive appetite remains high and there are still deals to be done, buyers are increasingly being forced to look at the lower end of the market as the pool of mid-market acquisitions dries up and competition for the best targets intensifies.

That being said, there is still considerable scope for M&A in the UK insurance sector. This, combined with the strength of the industry, means that it will continue to be a major driver of M&A activity across the broader services sector and will likely play a key role should the UK see a revival in dealmaking.

Communications: Gigabit push keeps telecoms centre-stage



In its 2019 general election manifesto, the Conservative party outlined a commitment to delivering nationwide gigabit coverage across the UK by 2025. The following year, following their victory in the election, this was unveiled as a formal plan, ultimately named Project Gigabit.

Project Gigabit is a £5 billion plan that aims to deliver next-generation gigabit broadband to more than a million UK households and businesses in the most hard-to-reach areas of the country by 2025.

The key objectives of the project are: delivering reliable, hyperfast broadband capable of download speeds of at least 1 gigabit per second to everyone in the UK; ensuring 85 per cent of UK premises have gigabit WiFi by 2025; and ultimately reaching 100 per cent coverage by 2030.

In an April 2024 progress report, the government announced that the UK’s gigabit coverage has increased to 81 per cent – up from just 6 per cent in 2019 – and that the milestone of connecting more than 1 million premises to gigabit-broadband had been passed.

This has, naturally, seen broadband providers undertaking huge infrastructure projects and the past few years has been notable for the emergence of “altnets” - alternative network providers that utilise their own independent infrastructure, rather than relying on existing copper or fibre optic networks.

Some of the biggest altnets include Gigaclear, Hyperoptic and CityFibre with the latter company having even been tipped as a potential challenger to industry incumbents Openreach and VMO2.

Given the diversity of the altnet market, in terms of both size and geographic coverage, it is unsurprising that there has already been a significant amount of M&A activity. In 2020, CityFibre acquired Fiber Nation, while Community Fibre acquired Box Broadband in 2021 and Swish Fibre took over People’s Fibre the following year.

While Project Gigabit is the overarching theme behind the growth of the altnets, they also have ambitious aims of their own. CityFibre, for instance, aims to cover up to 8 million premises across 285 cities, towns and villages (roughly 30 per cent of the UK) by the end of next year.

However, despite the rapid growth of the market and its huge strategic importance to the government’s strategy, many UK altnets (including CityFibre), have been hit by challenges including building suspensions and job losses, fuelled by rising costs and difficulties in raising new investment in a tough economic climate.

Against this backdrop, CityFibre has identified M&A as a key component of its strategy going forward, with consolidation seen as an effective way of helping the company reach its aim in an environment where financing is tight.

In January 2024, the company outlined its plans to make around five acquisitions over the next two years, with CEO Greg Mesch saying that a lack of investment meant there was “the opportunity to consolidate the network”.
At that time, Mesch said that CityFibre was in “exclusive talks” with two altnets, developing offers for three other firms and had entered non-disclosure agreements with another six providers.

In May, the company completed its acquisition of Lit Fibre from Newlight Partners. Lit Fibre, a network builder and internet service provider ISP, currently covers more than 220,000 premises across over 20 towns in Essex, Suffolk, Wiltshire, Gloucestershire, Hertfordshire and Worcestershire, as well as serving around 10,000 retail customers.

The acquisition was announced in March, with CityFibre spending the following two months working with Lit Fibre’s management team to begin the integration of its network infrastructure into its own, with the process set to complete later this year.

Following the deal, CityFibre intends to complete Lit Fibre’s work-in-progress deployment and the majority of the firm’s planned rollouts. The integration of Lit’s swift network will be prioritised, with CityFibre to assess options for its retail network following the integration. By early 2025, the network is forecast to reach a total of up to 300,000 premises.

CityFibre CEO Greg Mesch said: that the company has “already been working hard” with Lit Fibre’s team “to ensure that its network is integrated quickly”. Mesch added that the deal was “a great opportunity for us to hone our integration capabilities as acquisition becomes an increasing accelerant to our 8m plan."

In January, industry publication ISPreview, said that CityFibre could, theoretically, add between 1.5 and 3 million new premises to its network through M&A by the end of next year.

Despite this level of growth, the sector has still faced major challenges in recent years as a result of economic turmoil, with even bigger altnets such as CityFibre and Hyperoptic making significant job cuts.

In a recent report on the state of the industry, STL Partners forecast that some firms would begin selling off parts of their network buildouts, perhaps at a discounted valuation, to fellow altnets who are looking to grow their coverage in order to meet ambitious premises targets.

STL Partners wrote: “As the market continues to splutter, we expect more consolidation to occur before the end of the year. Engineering-centric AltNets whose business plans are proving hopelessly optimistic and/or whose commercial execution is failing may have to dramatically down-size or be snapped up completely by healthier competitors.”

“This will mainly be because they have not secured a high enough take-up, their customers’ business is of dubious quality, or their cost-base is simply unmanageable. Buyers can hope to purchase such assets at distressed prices.”
However, the early signs of an economic turnaround and the growing business activity reported across many areas of the service sector, could spell good news for struggling altnets.

As Project Gigabit approaches its next five-year-stage, and altnets seek to fulfil their network build plans, there may be a significant push from the government to drive investment into the sector, something that will be far more viable in a more stable economy.

Private equity investment may be ramped up in order to capitalise on an increasing number of distressed and solvent acquisition targets that are likely to be coming to the market over the next year, while altnets may benefit from recovering sentiment among businesses and residential customers.

What are the major challenges that remain?
Despite the optimism that is emerging around the services sector and the broader economy, there is no denying that major challenges still face owners and the sector at large.

Crucially, S&P’s report highlighted that job creation slowed during April 2024 to its lowest level this year, with companies focusing on limiting margin pressures in what remains an unforgiving economic environment. S&P also suggested that some companies are also struggling to attract suitable candidates for any vacancies that they do have, while rising wages have also contributed to slower job creation.

The increase in the National Living Wage has also contributed to input costs rising to their highest level since August 2023. Approximately 39 per cent of respondents reported that their average cost burdens had increased in April, compared to just 1 per cent who said that their costs had fallen, with service providers largely citing the impact of additional wage payments.

Efforts to pass these growing costs on also seem to have had mixed results, potentially putting further pressure on service sector businesses. While S&P reported that there was “another robust rise in prices charged by service sector companies” they also noted that prices rose at their slowest rate for three years and cited “reports that competitive pressures had constrained pricing power and led to some promotional discounting.”

S&P’s Tim Moore commented: "Relief at a turnaround in the economic outlook was commonly cited as a factor supporting sales pipelines in April. However, there were also reports that clients remained somewhat risk averse and under pressure from elevated inflation. These undercurrents constrained margins and meant that some service sector companies were cautious about taking on more staff. The overall rate of job creation was only marginal in April and slipped to its weakest so far in 2024.”

The report also highlighted the major threats to further growth in business activity as: “election uncertainty, elevated interest rates and fragile global economic conditions”. Since the report was published, these headwinds have intensified.

In late May, Prime Minister Rishi Sunak made the unexpected announcement that the General Election would be held on July 4, upsetting forecasts that the poll would be delayed until the second half of the year.

While the fixed date may ease some of the uncertainty that had been attributed to the election, the Labour party’s significant lead in the polls and its mixed signals about potential tax rises mean that businesses face a nervous wait to see if their tax burden will increase in the coming months.

From an M&A perspective, the early election date may mean that owners who had been considering exiting prior to the election in order to lock in a favourable tax may now be unable to do so in time, or could face having to majorly accelerate their plans and potentially accept a lower valuation.

Inflation, meanwhile, has continued to fall this year, but not at the rate many expected, leading to doubts that an interest rate cut will be imminent and potentially meaning that both consumers and businesses face ongoing cost pressures.

These headwinds indicate that it is far from plain sailing for service sector businesses and that any recovery will be gradual and fraught with difficulties. However, the signs are there that a recovery is taking root and that optimism is growing among service providers and consumers.

While insolvencies will continue and distressed acquisition opportunities are likely to remain plentiful for some time, growing business activity and economic improvement mean that service sector buyers can begin to focus on strategic acquisitions that could enable them to capitalise on a potential economic upturn.

Browse UK service businesses for sale

Share this article

Latest Businesses for Sale

---

---

---

View more businesses for sale