Looking Ahead: The Mid-Market Mergers & Acquisitions In 2016 by Mergermarket
The North American mid-market mergers & acquisitions has cooled somewhat this year after a huge 2014. But with so many factors at play, what do the next 12 months hold?
Mergermarket (MM): As we head into the New Year, what are the current factors defining mergers & acquisitions in North America’s mid-market?
Jerry Black (JB): The market has been driven by factors such as the low cost of financing — principally as a result of low interest rates — economic stability, positive economic growth in the United States compared with most of the rest of the world and the demographics resulting in baby boomers reaching retirement age. With the latter, they are wanting to sell their companies, primarily to generate liquidity and to maximize current market values.
In addition, many companies are now more inclined than they were in the past to pursue growth through acquisition. They recognize that the purchase of an existing business that aligns or expands upon current operations is a faster path to growth, or that certain new or synergetic business lines and support capabilities will complement their business operations and growth.
Important limiting factors as a result of recent acquisition activity in mergers & acquisitions generally, including the mid-market, are a smaller supply of quality acquisition targets and increased valuations. Finding companies which do not have inflated valuations and do not create excessive risk in terms of meeting the acquirer’s financial and business objectives will be more of a challenge. In light of the larger transactions consummated more recently, competitive pressures are causing an increase in mid-market transactions in order to accelerate growth and result in higher valuations.
T. Patrick Hurley, Jr (PH): For the owner/operator, family business or entrepreneurial group, it’s been a question of whether it’s time for them to do something. If we’re talking about selling — whether it’s based on age, health or having a good record — they don’t want to go into poor market conditions, but the market conditions are less of a factor than whether it’s time for them to consider something. In one recent case, it’s been because there was a significant funding issue related to the scale that they needed to be — this was a company doing about $80m in revenues that decided that rather than go out and possibly get stomped, they needed to find a partner that had the strength and motivation that would pay them a very nice value, and were willing to do it on a combo of about 50% current in the price and 50% in an earnout where they really believed in it.
Elsewhere, we had an owner of a hospitality operation who was being told by everyone he was rich, but he didn’t feel like he had enough money in the bank. After he talked with us we did a transaction with his existing bank that got him nearly all of his previously taxed capital out of the business, and no sponsor, no dilution in equity and a reasonable debt level. It’s altogether a different environment from the sponsor because they’ve paid a high price, and it becomes very difficult for management teams to ever meet their expectations.
Eric Zoller (EZ): For private equity (PE), the overarching theme in the market is one of contrast. From a seller’s perspective they are beginning to view the market as potentially having peaked. We haven’t quite seen a softening of their demands for prices necessarily, but I think maybe now there’s a realization that it’s time to think about exiting if you haven’t done so. There’s increased volatility in the market, and people aren’t sure for how much longer the markets will hold up.
Dry powder still continues to be at a post-crisis high, with about $400bn of dry powder. On top of this, there’s roughly 2,300 funds seeking $770bn of new capital. That means the number of players chasing deals and entering the market continues to grow each quarter. And as more and more money flows into the market, that should provide near-term support.
Another driver of pricing has been the rise of direct lending funds. Rather, it’s actually a symptom of the market in many ways. Several years ago the total capital raised for direct lending funds was $7bn. Now, that is closer to $35bn over the last four years. This is being driven by the strong demand by sponsors and others for lending, given the rise in deal activity.
Despite the strong deal flow and heavy dry powder, the contrast is that buyers themselves are becoming more concerned about valuations as we hit the peak of the market. They’re sitting on this dry powder a little longer, trying to be more thoughtful about picking their spots. A few years ago, 80% of the market was PE-backed. Now our stats show that mergers & acquisitions activity for PE sponsors is closer to 45%. That’s a big drop.
David Horing (DH): Two factors I would highlight would be interest rate sentiment and wider issues facing the global economy. Interest rate sentiment, and the uncertainty over the timing of rate increases, has created increased volatility in the debt and equity markets. This in turn has the potential to lower confidence amongst business leaders and may also serve to dampen valuations. Regarding the wider economy, the slowdown in China is trickling through to US businesses. One significant impact has been falling commodity prices, which influences our economy in multiple ways. Secondly, the strengthening of the US dollar has become a noticeable drag on some US businesses, putting pressure on earnings.
MM: What do you think will happen to commodity prices in 2016, and how will that impact US and Canadian mergers & acquisitions in the mid-market?
JB: In light of continued economic weakness in much of the world, especially in countries such as China and Brazil, there is likely to be reduced demand and continued weakness in the prices of commodities, particularly oil. This should have a positive impact for reduced operating costs of mid-market companies, as well as businesses and consumers generally, and should improve the revenue and profitability of target companies.
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