RSM B2B And B2C Spotlights: Value Spikes Among Lower Volume via PitchBook, by RSM US
Perspectives On The Real Economy
The underlying fundamentals of the U.S. economy remain solid. Inflation-adjusted final sales increased by 3 percent overall in the third quarter, with household outlays advancing 3.2 percent. Financial conditions have improved, following a rough August and September caused by concerns over the economic slowdown in China and emerging markets. On a monthly basis, employment gains are increasing by roughly 200,000, and average hourly earnings are up 2.5 percent on a year-ago basis, which is in line with wage and salary increases in the Employment Cost Index, all of which should underscore another solid quarter of spending and hiring to close out 2015.
Firms with exposure to the external sector, especially those who derive over half their revenues from abroad, continue to face a loss in competiveness, due to the appreciation of the U.S. dollar and the general deceleration in global economic demand. Thus, the portions of the domestic manufacturing base, with the exception of autos and aircraft, will likely continue to see very modest growth during the final three months of the year, with some industrial sectors contracting.
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Demand for business products remains stout, with strong gains in most areas, with the notable exception being in industrial equipment. Outlays on equipment increased 5.3 percent, and intellectual property products improved at a 1.8 percent pace, both on a seasonally adjusted annual rate through the end of September 2015. Outlays on information processing increased $13.3 billion, transportation equipment was up $9 billion and spending on software increased by $1 billion. Spending on industrial equipment declined by $2.6 billion over that same period.
B2B At A Glance
Company quality hinders deal volume The U.S. business products and services (B2B) sector continues to work through a transitional period in an everdynamic mergers and acquisitions (M&A) environment.
Revenue growth remains a struggle for many enterprises, and while strategic acquirers continue to seek out synergistic combinations, private equity-backed M&A activity paused somewhat during recent quarters, likely due to a reassessment period, as investors gauge the global investment landscape. Current valuation levels also haven’t helped when it comes to PE investment. Multiples are trending a bit lower, yet they still remain fairly heightened, and as deal-makers look to evaluate deal prices, the decline in volume last quarter is potentially attributable to a drop in the quality of targets coming to market that can command the price levels seen as of late.
“It appears there is a deemed softening of multiples to come, and so there are companies going to market earlier than they should ,and more aggressively than normal to take advantage of the downward trend,” says Milton Marcotte, practice leader of transaction advisory services at RSM US. That said, next quarter might be poised to make up some of the lost volume seen over the recent period. “I’ve seen many letters of intent (LOIs) signed in the last couple of weeks with a November or December close goal, so a flurry of activity could be coming,” iterates Marcotte.
As the Federal Reserve has yet to raise interest rates, the conversation surrounding the topic is still a popular one, although a rate hike alone will not halt or overly slow M&A activity. Instead, dealmakers have been more focused on global economic concerns when evaluating targets. “I think a lot of people have priced in a rate increase when looking at companies, so the broader concern is what’s the economy doing, and is there growth to be had,” says Marcotte. “The raw economic outlook is probably more important than just a 25 to 50 basis point increase in rates.”
One potential concern that stems from a rise in rates is the effect that phenomenon will have on the high-yield bond market. A series of rate hikes may encourage a continuation of the sell-off seen in junk bonds last quarter, as risk-free bonds begin providing more attractive yields, and thus, the yield necessary to entice buyers into purchasing this debt will rise. Speaking to this dynamic, Marcotte explains that the implications of a rate hike relates to the amount of affordable debt buyers will be able to put on target companies as they evaluate deals, much of which comes through the junk bond market. Nonetheless, lenders are still very aggressive, he states, due to an extremely competitive environment, so the debt to fund certain M&A transactions will remain present.
As energy prices began to move lower last year, a common assessment was that B2B businesses—especially in products and transportation—would be able to benefit from lower input costs. That has yet to be seen, however, as primary costs related to health care benefits and payrolls have offset a substantial amount of any savings driven by subdued energy prices. Talent acquisition has been difficult for many companies, and as they struggle to find the right candidates to help facilitate growth, a rise in existing employee salaries has followed.
“When I talk to CFOs and COOs, they’re saying they need more people,” states Mark Gaines, a partner with the business and professional services practice at RSM US. “They see a lot of opportunity in the B2B sector, but they say they can’t find the people to measure up with the opportunities. Now you have a tight market and have to pay up for it.” Further, workforce-intensive businesses require substantial health care benefits, a heightened cost buyers have to examine, as those trends are likely to remain in place going forward. With buyers needing to adequately evaluate these costs, discrepancies between sellers and buyers have arisen, due not only to value, but also a diminishing in the time frame sellers are willing to wait to close deals, which hints at a future softening in the market. “There’s just a lot of noise going on in certain companies, and it’s hard to get the buyers comfortable in the short time sellers are giving them to get it closed,” Marcotte states. Activity could pick up, as some of the LOIs begin to bear fruit, boosting completed transaction count, but persistent concerns around valuations and the quality of companies coming to market are likely to remain present.