In the first nine months of 2004, the number of middle market M&A transactions increased by 7.3 percent over the same period in 2003. The value of these transactions grew by 20.1 percent, as purchase price multiples rose to their highest levels since 2000. This growth in M&A transaction volume and value was driven by readily available debt and equity capital, and by better economic performance, topped by third quarter GDP growth of 3.7 percent.
While the overall economic outlook is positive, economic and geopolitical risks do present significant concerns for 2005. The federal budget deficit will need to be addressed, and economic growth may be slowed by rising interest rates and inflationary pressures in key commodities, including oil.
What to focus on in 2005
Equity and debt capital remain plentiful, and all signs indicate these markets will remain liquid in 2005. The private equity community entered 2004 with a surplus of funds to invest and had a strong fund-raising year. As a result, aggressive bidding by financial sponsors eager to put capital to work should keep leveraged buyout purchase price multiples at or above their current levels. Banks and institutional investors also continue to support higher acquisition prices by lending at higher multiples of debt to EBITDA.
Many companies have used their strong 2004 financial performance to reduce debt and build up cash. Now, with better balance sheets, these firms are considering growth opportunities, including acquisitions.
Brown Gibbons Lang's (BGL) current transactions are generating markedly higher levels of interest from corporate acquirers, signaling that an improved economy and greater earnings visibility are creating corporate demand for strategic acquisitions. It is this combination of liquidity in the private equity markets and heightened activity by strategic acquirers that has resulted in higher valuation multiples.
The accelerating pace of globalization throughout the economy and increasing cross-border M&A activity are other important trends for owners and managers to monitor in 2005. As firms take advantage of efficiency gains through outsourcing and offshore production, and seek growth opportunities in foreign markets, they also identify strategic international acquisition targets. Strikingly, this is also true in the middle market.
For example, in the first nine months of 2004, transactions with disclosed values in which a U.S.-based company acquired a foreign firm grew 17.5 percent over the same period one year earlier. Acquisitions of U.S. firms by foreign-based companies increased 12.7 percent. BGL and its partners in Global M&A, a partnership of 24 top middle-market investment banks around the world, have completed more than 400 transactions since 2000. Global M&A's cross-border pipeline for 2005 is more robust than ever before.
Entering 2005, business owners and managers should anticipate a positive economic environment and continued liquidity in debt and equity capital markets. For these reasons, it remains an opportune time to purchase or sell a middle-market business.
However, given significant macroeconomic and geopolitical uncertainties, these conditions may change rapidly and without notice. We recommend that owners and managers considering major corporate finance or M&A transactions should execute their plans early in the year to capitalize on the current favorable conditions.
Craig A. Korte (email@example.com) is vice president of Brown Gibbons Lang & Co. He focuses primarily on Mergers & Acquisitions and corporate restructuring. Reach him at (312) 658-1600.
Third quarter GDP growth, at 8.2 percent, marked the highest rate recorded in nearly 20 years. Corporate profits, which had remained a weak link in the nascent economic recovery, were up 30 percent in the third quarter. Publicly available data and anecdotal reports from our clients indicate that the outlook for 2004 is solid across the economy, including the rebounding manufacturing sector.
In the second half of 2003, the M&A market also demonstrated improved fundamentals, including a significant reduction in bankruptcy-related transactions. Private equity firms, which were a key driver of M&A activity throughout 2003, continued to deploy capital aggressively in the third quarter, completing the highest total number of deals since the fourth quarter of 1999.
Strategic acquirers also are returning, albeit cautiously, to the M&A market. Brown Gibbons Lang & Co.'s current transactions are generating markedly higher levels of interest from strategic acquirers, signaling that an improved economy and greater earnings visibility is creating corporate demand for strategic M&A opportunities.
This combination of liquidity in the private equity markets and heightened activity by strategic acquirers should lead to higher valuation multiples in 2004.
What to focus on in 2004
Brisk economic growth will provide a respite from the punishing conditions of the past three years. Management teams, including those in the middle market, should capitalize on improved operating performance and a period of robust M&A activity to execute critical strategic and financial initiatives that position their companies for future success.
In particular, management teams in both the manufacturing and services sectors must maintain focus on the relentless global competition that has become a permanent feature of the economy. In order to maintain viability in this environment, management teams must continue to expand productivity, shed noncore assets and develop businesses that are strategically defensible in the face of offshore competition.
Perhaps counterintuitively, these efforts may involve adding risk in the short term. For example, developing offshore production capabilities may require significant investment, but may be the only way to protect a business over the long term.
Banks and other capital providers are increasingly sensitive to the risks of foreign competition and supportive of investments that enhance competitiveness. In addition, many private equity firms with offshore expertise are seeking opportunities to provide capital and operational resources to businesses developing global strategies.
Positioning a business for the future also may involve altering its ownership structure. Owners of private companies should evaluate whether they have the ability and appetite to incur the risk required to grow their businesses and remain competitive. If not, market conditions in 2004 will present an excellent window for attaining liquidity.
Similarly, management teams of public companies or divisions of public companies need to evaluate whether public ownership provides financial and other resources that enhance the competitiveness of their business or whether the cost and reporting scrutiny associated with public status actually detracts from their ability to compete. If the latter is true, a going-private transaction or the buyout of a division by management may be the value maximizing alternative.
In 2004, owners and management teams should enjoy an unusual combination of improved operating performance, an easing credit environment and a highly active M&A market. This will provide an exceptional opportunity for owners and management teams to either capture the value of their businesses at an attractive valuation or to pursue strategic initiatives that will increase competitiveness and create value over the long term.
Craig A. Korte (firstname.lastname@example.org) is vice president of Brown Gibbons Lang & Co. He focuses primarily on mergers and acquisitions and corporate restructuring. Reach him at (312) 658-1600.