By Duane P. Donner II, Managing Partner
2015 M&A REVIEW
The numbers are still being tallied, but we already know that 2015 proved to be a record year for global M&A activity. Dealogic reported in late December that global M&A activity will exceed $5 trillion, the highest aggregate value ever, up 37% from 2014 ($3.67 trillion). This increase, however, was driven by mega deals, with 69 deals over $10 billion in value and 10 deals over $50 billion.
Once you remove those deals from your dataset and look at middle-market deals, Founders’ focus, the legs of this buyout cycle look like they are starting to tire. Mergermarket says North America mid-market deals were down slightly in 2015, while multiples appeared to crest. According to PitchBook, valuation multiples on private equity (PE), although still high on a historical basis, started to slide in 2015. Their data suggests deal multiples and deal debt levels returned to 2012 levels. It is believed that the depressed energy sector played a large part in that contraction. Over all, the data suggests more caution in the market as the depressed energy sector impacts peripheral markets such as metals and transportation; uncertainty persists regarding emerging markets, particularly China; and the Fed begins to raise interest rates. However, despite the caution, there is still a lot of dry powder in both private equity funds and on corporate balance sheets.
PitchBook reported that U.S. private equity activity remained strong in 2015, but also moved lower relative to 2014 both in deal flow (down 8.2% YoY) and aggregate transaction value (down 4.8% YoY). Despite the downturn, PE groups continued to fundraise at a healthy clip. U.S. PE vehicles raised $181 billion in 2015, down 11% versus 2014, but dry powder remains very high as U.S. GPs have raised $760 billion across 1,252 funds since 2010. According to Preqin, a leading source of data and intelligence for the alternative assets industry, global PE dry powder is over $1 trillion, with nearly half of that in buyout funds. Also of note, despite the prolonged and deep downturn in the energy sector, U.S. PE funds raised over $35 billion for energy investments last year, while energy deals fell over 50%. This points to “smart money” getting poised to scoop up distressed assets in the energy sector as sustained depressed oil prices causes over-leveraged companies to close their doors.
While PE buyers tapped the breaks, strategic buyers hit the gas and were very active in 2015. In general, strategic buyers did not participate as heavily in the early innings of this buyout cycle, but in line with cycles of the past they are now coming on strong in the latter innings. This is primarily driven by balance sheets flush with cash and the need to grow faster than the overall economy. As of June of 2015, Standard and Poor’s Ratings Services’ universe of 2,000 U.S. nonfinancial companies held $1.82 trillion in cash, cash equivalents, and long-term investments. Founders Investment Banking, or principals thereof, advised on nine sell-side transactions in 2015; seven of those deals involved strategic buyers. Private equity was at the table in almost every deal, but at the end of the day strategic buyers were willing to pay more and provide more advantageous terms to the seller.
2016 M&A OUTLOOK
Overall, we expect 2016 to be another strong year for middle-market M&A, but we do think the window for this buyout cycle is in its latter innings. Our reasons for that viewpoint are as follows:
- The Length of the Current Economic Recovery Exceeds the Average. We are 78 months into the current economic recovery. Since 1854, the average is 39 months and the post-war era average is 58 months. The longest expansion we’ve seen since that same time has been 120 months from March 1991 to March 2001.
- Systemic Risk in the Market. We’re entering 2016 with a few large economic uncertainties or systemic risks present in the market, including the spillover effect of a depressed energy sector, uncertainty around emerging markets, particularly China, and a rising interest rate environment.
- Peak Multiples. Recent data and our own experience suggests while valuations are still high relative to history, they are beginning to crest in the current cycle.
- PE Behavior. PE firms are slowing their buying, increasing their exits and beginning to raise funds for distressed assets. 2015 was a record-breaking year for PE exits. More than $321 billion was exited across 1,132 transactions, a 10% increase in exit value versus 2014. Despite record fundraising, PE investment-to-exit ratio was 1.7x in 2015, and an average of 1.9x for the past four years (2012-2015), versus 3x in the preceding four-year period (2008-2009). In addition, and not including the $35 billion raised for distressed energy assets, $11 billion was raised by distressed debt PE funds, more anecdotal data that some believe we are nearing the end of the current buyout cycle and are positioning to capitalize in a downturn.
That said, there is a lot of liquidity among PE funds and corporate balance sheets alike, and interest rates, although rising, are extremely low relative to other periods. While we are in the last innings, the question of how long these innings will play is extremely hard to predict. Based on this viewpoint and the data that supports it, we are advising business owners who were planning to exit in the next two to three years to consider exiting now so they don’t miss the current window; otherwise, it may be five or more years before they can exit with the valuations we’ve seen the last couple years.
Timing is very important when considering M&A, and there are both internal and external factors you need to investigate and understand, including shareholder needs, business lifecycle, industry dynamics, capital markets, tax implications, etc. Some of these factors you can control and some you can’t. Currently, the external factors are favorable, so business owners considering an exit or recapitalization in the foreseeable future would be prudent to go ahead and take a look at their options and possibly accelerate their timelines. Selling at the right time can be the difference in not only receiving an outsized valuation, but in getting a deal done at all.
Because of the competitive M&A environment, many private business owners are experiencing increased unsolicited interest from both private equity and strategic buyers. This was the case with two of the transactions Founders closed in the first quarter. Receiving such calls can be exciting for owners, but we want to caution sellers against entertaining this unsolicited interest without having assistance from experienced and trusted M&A advisors. Many private company owners underestimate what’s involved in preparing a company for sale and achieving the best outcome. Most business owners will only sell their companies once, and it is oftentimes the largest single transaction of their lives. In that regard, it is very prudent to proactively build and prepare your company for M&A and seek professional help in the process. This takes time and intentionality, but really can create tremendous value if done properly. Reacting to a solicitation from suitors and pursuing one-off transactions generally does not end with the most favorable result. Running a proactive sell-side process will always yield the highest valuation and typically result in achieving a premium valuation.
About Founders Investment Banking
Founders Investment Banking (Founders) is a merger, acquisition & strategic advisory firm serving middle-market companies. Founders’ focus is on oil and gas, SaaS/software, industrials, internet, digital media and healthcare companies located nationwide, as well as companies based in the Southeast across a variety of industries. Founders’ skilled professionals, proven expertise and process-based solutions help companies access growth capital, make acquisitions, and/or prepare for and execute liquidity events to achieve specific financial goals. In order to assist Founders Investment Banking with securities related transactions certain Principals are registered investment banking agents of M&A Securities Group, Inc., member FINRA/SiPC. M&A Securities Group and Founders are not affiliated entities. For more information, visit www.foundersib.com.