Companies that are performing in the top quartile of their respective industries have many M&A options.
“Valuations for high-performing companies have never been better, buyers never more plentiful,” says Mike Burr, senior managing director, head of mergers and acquisitions at Fifth Third Securities.
Even though economic conditions are good, the supply of interesting, quality opportunities is limited, making analyzing the M&A market precarious.
“Companies that are not high performers in their industries should carefully consider their expectations of value before initiating an M&A process,” says Doug Wyatt, executive vice president, senior commercial banker at Fifth Third Bank.
Smart Business spoke with Burr and Wyatt about the M&A market and what strategic and financial buyers can expect this year.
Why hasn’t U.S. M&A activity more closely followed the positive economic news?
There is a significant focus on the multi-billion dollar transaction during the past 18 months, with transactions of over $1 billion dominating M&A headlines and corresponding transaction activity. The broad M&A market, which in 2014 was only modestly improved from 2013, understates the underlying positive conditions of the U.S. market. Significant liquidity, both from financial and strategic buyers, and a very low rate environment, create a very positive backdrop for sellers.
Between 2010 and 2013, middle market companies sought and executed various strategic recapitalization transactions to satisfy many of their liquidity goals. Many of these private business owners accomplished those goals and are currently struggling with the benefits of a full sale process despite a very positive market. That has sellers wondering where to invest their proceeds.
What industries are leading the way?
Health care and energy are notable industries of anticipated activity, but for different reasons. The aging population will help the health care industry continue year-over-year double-digit growth rates.
In energy, the falling oil prices mean many companies dependent on higher oil prices are faced with overleveraged balance sheets, which will create operational challenges and drive transaction activity in the second half.
What caused the year-over-year decrease in first quarter 2015 deal activity?
We’re seeing a period where the benefits of liquidity are not an exclusive focus of many private and small cap/middle market business owners. Many have already satisfied this need. The Q1 2015 middle market marketplace reflected this lack of motivation, with transaction levels down 20 percent. However, the large billion-dollar transaction activity continues unabated and is driving the overall M&A market.
Is the market overvaluing transactions?
This is always a big question when you see average valuation multiples exceeding double digits (as multiple of EBITDA).
Historically, when M&A valuations exceed the valuation multiples of the overall public market indices, it’s an indication we are approaching an overheated environment.
Corporate balance sheets and private equity funds have never been this liquid. How are they going to deploy this capital?
There’s just not the level of attractive transactions, so it’s likely that for the balance of 2015-16, valuations for solid, top quartile growth companies will remain high. This will challenge corporate and private equity balance sheets to put liquidity to work. However, the corporate buyers participating in the billion-dollar M&A market are starting to put a dent in their cash stockpile.
Are the new lending regulations hindering M&A activity?
It appears so. However, what is actually happening is a shift in the cost of capital as banks examine their leverage portfolios and pull back their leverage lending initiatives, which will likely increase as federally mandated leverage guidelines gain clarity. The reduction of less expensive bank capital will put more pressure on buyers and their cost of capital as more expensive alternative financing replaces bank financing.
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