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Selling Opportunities In Mid-Market M&A Abound, Despite Dip In North American Deal Activity

Selling Opportunities In Mid-Market M&A Abound, Despite Dip In North American Deal Activity by Firmex

A new report from Firmex  in partnership with Mergermarket, Mid-Market M&A: Deal Environment for Sellers, reveals that business owners can best position themselves for sale in the current environment by performing rigorous sell-side due diligence, knowing how to handle activists, and exploring the advantages of strategic versus private equity buyers.

As global volatility continues, North American mid-market M&A has hit a downturn. In the first five months, the value of mid-market deals in the region sunk 10% year-over-year to US$56.9bn, while volume fell even more sharply, to 655 deals from 896. After several years in which sellers could dictate terms, it has become a buyer’s market in many sectors. And yet, selling opportunities continue to arise and according to four top dealmakers, a variety of sectors will show favorable conditions.

Mid-Market M&A: Deal Environment for Sellers

North America has seen a dip in deal activity this year, with volume and valuations down. How can sellers cope with the vagaries of the current M&A environment? Four experienced mid-market dealmakers weigh in.

  • As volatility continues on world markets in mid-2016, North American mid-market M&A has hit a downturn. In the first five months of the year, the value of mid-market deals in the region sunk 10% year-over-year to US$56.9bn, while volume fell even more sharply, to 655 deals from 896. After several years in which sellers could dictate terms, it has become a buyer’s market in many sectors.
  • And yet, selling opportunities will continue to arise. The question for sellers is: How can a company best position itself for sale in this environment?
  • In our expert roundtable, four top dealmakers detail the key steps business owners should take to optimize value. They also describe approaches for handling activist shareholders; the advantages of strategic vs. private equity buyers; and the qualities in a buyer that sellers should focus on most.
  • In the end, valuation is king when it comes time to sell. But achieving that optimal deal value – and closing the deal quickly – require a well-informed plan of attack.

Mergermarket (MM): Early 2016 has been a buyer’s market in many sectors, especially those such as Energy and Mining. Given this environment, what are the key steps for midmarket companies to take in order to receive optimal value in a sale?

Mary Ann Travers (MAT): Private company sellers need to make sure they’re putting their best foot forward. Part of that entails analyzing their operating expense bases and preparing financial statements that reflect their company’s operations in a favorable light. They should remove non-operating expenses; identify off-balance-sheet items; and make sure that their headcount is optimal, although not too lean, since they want to achieve their forecasts. When preparing their forecasts, they should make sure that they’re capturing growth opportunities and that they have supporting documentation to back up their assumptions.

Sell-side due diligence really helps mid-market companies get ready for sale as well. In our practice, we walk them through the kinds of things they need to do to clean up their operations and to be mindful of as they prepare their forecasts. For instance, many privately held, smaller mid-market companies have non-operating items and extraneous expenses that don’t truly contribute to the business operations, which is just a function of the nature of a private company. When they look to sell, they should make sure those things are cleared away.

Michael Teplitsky (MT): This year did kick off with a bad start for many sellers. Many of the businesses that Wynnchurch pursued saw reductions in backlog and unfavorable customer-demand trends. To make matters worse, the debt capital markets significantly deteriorated in the first quarter. The sub-industries under the most pressure were, of course, Metals, Mining, and Energy. To maximize shareholder value in this soft economic environment, sellers of mid-market companies must convince buyers that their company is differentiated and defensible; that there are attractive growth opportunities (such as tuck-in acquisition targets) available in the short and medium-term; and that the company generates attractive levels of cash flow. Sometimes, maximizing value may require the seller to take contingent consideration, such as an earn-out or an equity roll-over.

Companies should also make sure that the right management team is in place to achieve their growth potential. The shareholders should form an interdisciplinary advisory team to get optimal advice before a sale process starts. They should consider including one of each of the following: wealth manager, attorney, accountant, M&A advisor, commercial lender, operational consultant, market consultant, and board member or senior industry advisor. Also, having preemptive conversations, also known as “fireside chats” or “gold card meetings,” with potential strategic or PE buyers may be a catalyst for identifying a “unicorn buyer” (i.e., an outlier high bid) without having to run a large auction, which may distract management from core business operations. UBS Investment Bank smartly deployed this strategy in the recent sale of Wynnchurch’s Wolverine Advanced Materials to ITT Corporation for US$300m.

Jeff Cleveland (JC): As head of D.A. Davidson & Co.’s Food, Beverage & Agriculture investment banking practice, I spend most of my time working with clients in the food and beverage, and more broadly, consumer markets. In these segments of the economy, it is still very much a seller’s market. Given the themes reshaping these industries and the limited supply of high-quality investment opportunities, relative to the demand for investment, we don’t see this changing in the near-term.

Nonetheless, we counsel all of our clients to take deliberate steps to properly prepare in advance of a transaction in order to optimize results. Ideally, owners and executives are networking with key intermediaries (attorneys, accountants, lenders, investment bankers, etc.) years before they launch a marketing process to seek outside capital. These conversations should allow owners and executives to better understand how outside investors will view their business.

Generally speaking, areas of focus tend to include business operations, customer and supplier relationships, market dynamics and growth opportunities, and facilities and equipment. Assessing and adjusting a business around these key areas can facilitate meaningful value creation by the time shareholders execute a sale.

Fundamentally, this sort of preparation is simply about building a better business for the longterm. Investors will take note of these sorts of improvements, above most things.

Jim Kofman (JK): I always tell clients: There is no such thing as a general market approach when it comes to achieving the best valuation for your business. It is entirely sector- and geographydriven. What might make sense today in gold and silver is entirely different than what might be right for copper, and what is logical in Mining is entirely different than in Healthcare. Timing is also key – what makes sense today is different than it was six months ago. So it is really about understanding the individual industry and the food chain in that industry – who the buyers are and who needs what at any given time.

The type of sale process is important as well. Many people assume that the best way to get value is to run a broad auction and create tension. But there are lots of buyers out there who don’t want to spend the time and money to go through an auction process where they have a 1-in-10 chance or a 1-in-20 chance of winning it.

Mid-Market M&A
Mid-Market M&A

They want a company to engage with them one-on-one instead – and sometimes they’re willing to pay a good price. There’s no one right or wrong answer, and it really depends on the company. Are there 10 companies that would be keen to buy you? Or is it clear that there are one or two logical buyers? That’s probably the most important thing to figure out up front when considering how to achieve optimal value.

MM: Amid the buyers’ market and slowing economic growth, are there sectors in which favorable conditions are persisting for mid-market sellers? If so, which?

JC: We continue to see strong interest across the full spectrum of the consumer marketplace: Food, Beverage & Agriculture, Consumer Products, Retail and Restaurant, and Consumer Services. Investors are particularly interested in putting capital to work behind opportunities that connect into better-for-you food and beverage and active lifestyle consumer products, collectively an area we think of as “better living.”

Mid-Market M&AGenerally, retail remains a challenging segment within the consumer landscape. That being said, there is still strong investor interest in retailers that are performing well and uniquely positioned to avoid competition from Amazon and other online channels. Additionally, investors are hungry to put capital behind restaurant concepts with strong unit-level economics and attractive growth prospects. Beyond consumer, we continue to see strong activity in diversified industrials, infrastructure, financial services, and technology. While the energy markets have been challenging, investors are becoming increasingly active and we see good long-term prospects in the industry.

MAT: We play in a whole host of sectors and industries, but I would say the Healthcare, Technology, and Manufacturing sectors remain strong at the moment. We’ve also seen some unique growth in certain niche areas, such as architectural, engineering, and utility-related services. Regardless of sector, I’d say that we are seeing a plethora of add-on deals driving the market. Buyers are keenly interested in producing market-share increases, coming up with new service or product offerings, and expanding into new geographies to help them drive growth beyond what they can accomplish organically.

JK: Ironically, the sector that was probably most out of favor only six months ago is probably the hottest sector in Canada right now, which is gold and silver companies. The average gold company has seen its stock triple since mid-January. They were way down, but the speed at which they’ve recovered has been nothing short of incredible, and no one saw it coming. The companies that were hobbled and under financial pressure to sell have now been able to access capital markets and fix their balance sheets. Some of these companies are also ready to start buying again as a result — even though the companies they’re targeting have often recovered in value as well.

MT: There are three Industrial sectors seeing favorable conditions right now: Building Products, driven by the recovery in U.S. housing starts and construction spending; Aerospace, driven by the increase in air travel and the need to replace aging Boeing and Airbus fleets; and Automotive, driven by the booming demand for new cars by the recovering US consumer. Wynnchurch has recently made strategic investments within these themes: Latham Pool (swimming pools), Gypsum Technologies (capital equipment for wallboards), Indiana Limestone (architectural stone), and Carson Air (air ambulance and air cargo services). Additionally, mega themes such as “water” continue to attract strong buyer appetite. Wynnchurch benefited from this trend with its April 2016 sale of US Pipe (a maker of pipe for water infrastructure) to Lone Star Funds’ Forterra Building Products.

Mid-Market M&A
Mid-Market M&A

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