Covering the Middle Market in Chicago and the Midwest
M&A CHICAGO
The Journal for Middle Market M&A Professionals & Dealmakers
The Journal for Middle Market M&A Professionals & Dealmakers
Thought Leadership
M&A in the Middle Market I The Road to Recovery - But Not For All
April 12, 2011
Credit
Continuing to look at the market from the perspective of deal size does indicate that, all things being equal, smaller middle market deals are harder to finance and as a result are less likely to close than like sized-quality larger transactions. While the general sentiment is that debt financing has returned to the middle market, credit appears to be somewhat less abundant when the targets normalized EBITDA is below $10 million. This unofficial $ 10 million threshold seems to be where financing flexibility becomes more limited and, in some cases, more expensive. Today's credit statistics support this point. Credit - or in this instance, the lack thereof - can affect private equity buyers who are looking for new platform opportunities and intend to use financial leverage to obtain them. In some cases, private equity buyers have "over-equitized deals" writing up to 100% equity checks to fund a purchase with the intent of recapitalizing their investment later. Buyers with existing bank lines, large cash war chests, or both, are less affected by these credit conditions and continue to seek businesses that can be folded into their existing companies or platforms.
Bright spots in the middle market M&A landscape
As always, industry sectors come in and out of favor, and today's market is no exception. For example, technology-enabled companies, high">
It is important to note that middle market technology companies are attractive acquisition targets right now for buyers across a variety of industries. Acquiring a small company for its technology rather than developing it in-house can be a cost effective and streamlined way to achieve IT-systems goals. In addition, rust belt industries are looking at investing in technology laden targets to reinvent their businesses, develop new competitive advantages, or return to stable profitability through operating efficiencies. Conversely, many technologically mature buyers believe that competitive advantages could result in the acquisition of middle market companies with solid brands or products that could benefit from added technological component housed on site. Following the buy vs. build theme, some larger companies are seeking middle market acquisition targets for product extension, marketplace expansion, or customer acquisition. It is often more cost effective and provides a more expedient time-to-market to purchase a company that fulfills these needs rather than assume the execution risk of developing a new product organically or expanding across geographies.
What's next?
Given the significant amount of capital raised and the anticipated supply of sellers from both private equity firms and family owned businesses, we expect to see a somewhat choppy increase in deal activity for the first half of this year with accelerated volumes during the second half of 2011 and early 2012. Middle market activity has traditionally dominated M&A activity by volume and the recovery in this segment that started in mid-2010 should steadily improve as GDP growth accelerates. However, the tough environment for middle market companies -- where quality and deal size can be primary drivers -- is expected to continue with valuations, both positive and negative, reflecting underlying corporate and diligence risks.
Dear Readers:
A lot to cover today in the article below, so right to business....
M&A in the Middle Market: The Road to Recovery--But Not For All
by Jerry Dentinger and Ken Csaplar
It is no secret, 2011 will likely be a rebound year for middle market companies when it comes to M&A activity. The question is, however, what deals will get done? When looking at the market as a whole, approximately 75 percent of the dollar volume of M&A deals are $1 billion and below. In addition, various industry sources estimate that anywhere between 60 to 80 percent of transactions, in terms of numbers of deals, are "middle market" with earnings before interest, taxes and depreciation ("EBITDA") of less than $10 million. Keeping in mind that as deal sizes decrease, "closing challenges" increase, it is important to understand the challenges middle market companies face that may not apply to larger companies and, to that end, how those challenges affect which deals are brought to the table.
It's a Bifurcated Market
It is fair to say that the recession has taken its toll on the operations and corresponding profitability of many companies. As a result, the markets can be bucketed broadly into the 'haves' and 'have-nots'. For the 'haves', those large and small companies that have shown little to no real reduction in profitability during the dark days of the recession and are demonstrating increased earnings, sell side prospects are good. There is a true "flight to quality" within the markets, and a desire on the part of buyers to purchase strong assets. Unless a buyer is focused on restructuring or distressed targets, the emphasis, today, is on purchasing high-quality companies. This is particularly true for private equity funds, many of which have spent the majority of the last two years focused on operational improvement and recapitalizing leveraged balance sheets under the close scrutiny of their investors. The majority of deals that were completed in the second half of last year, particularly within the private equity subsector, fit this high-quality, objective criteria, which is consistent with the recovery of the M&A market. In addition, quality deals saw healthy valuation multiples as a result of the significant availability of capital and limited supply of well-performing companies. In 2011, the quality theme continues.
Like the economy, the deal market continues to be in a recovery and transition period where companies are working to shore up their business models and corresponding operating results. As trailing twelve month EBITDA trends stabilize or improve, sellers hope to convince buyers their 2011 forecasts are a lock and they are now one of the companies that deserve a fully-priced valuation multiple. Despite this resiliency, selling challenges remain and companies in the market that have not recovered are receiving lower, sometimes dramatically reduced, valuations than they would have seen at the apex of the M&A market in 2007. This is particularly true for the lower end of the middle market where companies valued at $100 million or below may have found it harder to recover or grow their businesses. M&A activity in the middle market should, however, increase in the second half of 2011 and enjoy expanding valuation multiples as companies are able to gain financial traction and demonstrate improved quality of earnings. With this return to market, additional supply for the overhang of acquisition demand will improve.
Diligence, Diligence and more Diligence
For companies that have not fared well during the recession and are looking for transactions, the operative terms for buyers are diligence and patience. Middle market investors and lenders alike continue to 'peel back the credit onion' and take more time to close their deals. Areas of concern include: i) "negative synergies" or the need to reinvest in infrastructure and people in order to generate and sustain revenue growth, ii) the ability to pass along rising input costs at times when sales volume still lags behind historic levels and iii) pricing power and customer">
A lot to cover today in the article below, so right to business....
M&A in the Middle Market: The Road to Recovery--But Not For All
by Jerry Dentinger and Ken Csaplar
It is no secret, 2011 will likely be a rebound year for middle market companies when it comes to M&A activity. The question is, however, what deals will get done? When looking at the market as a whole, approximately 75 percent of the dollar volume of M&A deals are $1 billion and below. In addition, various industry sources estimate that anywhere between 60 to 80 percent of transactions, in terms of numbers of deals, are "middle market" with earnings before interest, taxes and depreciation ("EBITDA") of less than $10 million. Keeping in mind that as deal sizes decrease, "closing challenges" increase, it is important to understand the challenges middle market companies face that may not apply to larger companies and, to that end, how those challenges affect which deals are brought to the table.
It's a Bifurcated Market
It is fair to say that the recession has taken its toll on the operations and corresponding profitability of many companies. As a result, the markets can be bucketed broadly into the 'haves' and 'have-nots'. For the 'haves', those large and small companies that have shown little to no real reduction in profitability during the dark days of the recession and are demonstrating increased earnings, sell side prospects are good. There is a true "flight to quality" within the markets, and a desire on the part of buyers to purchase strong assets. Unless a buyer is focused on restructuring or distressed targets, the emphasis, today, is on purchasing high-quality companies. This is particularly true for private equity funds, many of which have spent the majority of the last two years focused on operational improvement and recapitalizing leveraged balance sheets under the close scrutiny of their investors. The majority of deals that were completed in the second half of last year, particularly within the private equity subsector, fit this high-quality, objective criteria, which is consistent with the recovery of the M&A market. In addition, quality deals saw healthy valuation multiples as a result of the significant availability of capital and limited supply of well-performing companies. In 2011, the quality theme continues.
Like the economy, the deal market continues to be in a recovery and transition period where companies are working to shore up their business models and corresponding operating results. As trailing twelve month EBITDA trends stabilize or improve, sellers hope to convince buyers their 2011 forecasts are a lock and they are now one of the companies that deserve a fully-priced valuation multiple. Despite this resiliency, selling challenges remain and companies in the market that have not recovered are receiving lower, sometimes dramatically reduced, valuations than they would have seen at the apex of the M&A market in 2007. This is particularly true for the lower end of the middle market where companies valued at $100 million or below may have found it harder to recover or grow their businesses. M&A activity in the middle market should, however, increase in the second half of 2011 and enjoy expanding valuation multiples as companies are able to gain financial traction and demonstrate improved quality of earnings. With this return to market, additional supply for the overhang of acquisition demand will improve.
Diligence, Diligence and more Diligence
For companies that have not fared well during the recession and are looking for transactions, the operative terms for buyers are diligence and patience. Middle market investors and lenders alike continue to 'peel back the credit onion' and take more time to close their deals. Areas of concern include: i) "negative synergies" or the need to reinvest in infrastructure and people in order to generate and sustain revenue growth, ii) the ability to pass along rising input costs at times when sales volume still lags behind historic levels and iii) pricing power and customer">
Credit
Continuing to look at the market from the perspective of deal size does indicate that, all things being equal, smaller middle market deals are harder to finance and as a result are less likely to close than like sized-quality larger transactions. While the general sentiment is that debt financing has returned to the middle market, credit appears to be somewhat less abundant when the targets normalized EBITDA is below $10 million. This unofficial $ 10 million threshold seems to be where financing flexibility becomes more limited and, in some cases, more expensive. Today's credit statistics support this point. Credit - or in this instance, the lack thereof - can affect private equity buyers who are looking for new platform opportunities and intend to use financial leverage to obtain them. In some cases, private equity buyers have "over-equitized deals" writing up to 100% equity checks to fund a purchase with the intent of recapitalizing their investment later. Buyers with existing bank lines, large cash war chests, or both, are less affected by these credit conditions and continue to seek businesses that can be folded into their existing companies or platforms.
Bright spots in the middle market M&A landscape
As always, industry sectors come in and out of favor, and today's market is no exception. For example, technology-enabled companies, high">
It is important to note that middle market technology companies are attractive acquisition targets right now for buyers across a variety of industries. Acquiring a small company for its technology rather than developing it in-house can be a cost effective and streamlined way to achieve IT-systems goals. In addition, rust belt industries are looking at investing in technology laden targets to reinvent their businesses, develop new competitive advantages, or return to stable profitability through operating efficiencies. Conversely, many technologically mature buyers believe that competitive advantages could result in the acquisition of middle market companies with solid brands or products that could benefit from added technological component housed on site. Following the buy vs. build theme, some larger companies are seeking middle market acquisition targets for product extension, marketplace expansion, or customer acquisition. It is often more cost effective and provides a more expedient time-to-market to purchase a company that fulfills these needs rather than assume the execution risk of developing a new product organically or expanding across geographies.
What's next?
Given the significant amount of capital raised and the anticipated supply of sellers from both private equity firms and family owned businesses, we expect to see a somewhat choppy increase in deal activity for the first half of this year with accelerated volumes during the second half of 2011 and early 2012. Middle market activity has traditionally dominated M&A activity by volume and the recovery in this segment that started in mid-2010 should steadily improve as GDP growth accelerates. However, the tough environment for middle market companies -- where quality and deal size can be primary drivers -- is expected to continue with valuations, both positive and negative, reflecting underlying corporate and diligence risks.
An Important Upcoming Event:
The 6th Annual Chicago Booth
Distressed Investing and Restructuring Conference
The 6th Annual Chicago Booth Distressed Investing and Restructuring Conference will be held on April 15th, 2011 at the University Club of Chicago. This year's conference keynote speakers include Howard Marks, '69, of Oaktree Capital Management, David Shapiro, '89, of KPS Funds, as well as case studies and panels covering distressed investing, legal issues, and innovations in restructuring. Presenters include the Blackstone Group, Rothschild, PIMCO and Centerbridge Partners.
The primary focus of the conference is to provide a broad overview of the state of the distressed investing and restructuring industry as well as a networking opportunity for professionals, students and faculty from around the country.
Click here to register or learn more.
Until the next issue,
Joe
Joseph DiPietro
Publisher & Sr. Managing Editor
publisher@machicago.com
+1 815 206 0780
The 6th Annual Chicago Booth Distressed Investing and Restructuring Conference will be held on April 15th, 2011 at the University Club of Chicago. This year's conference keynote speakers include Howard Marks, '69, of Oaktree Capital Management, David Shapiro, '89, of KPS Funds, as well as case studies and panels covering distressed investing, legal issues, and innovations in restructuring. Presenters include the Blackstone Group, Rothschild, PIMCO and Centerbridge Partners.
The primary focus of the conference is to provide a broad overview of the state of the distressed investing and restructuring industry as well as a networking opportunity for professionals, students and faculty from around the country.
Click here to register or learn more.
Until the next issue,
Joe
Joseph DiPietro
Publisher & Sr. Managing Editor
publisher@machicago.com
+1 815 206 0780
Jerry Dentinger is the head of the Midwest Transaction Advisory
Services practice for BDO USA, LLP. He can be reached at jdentinger@bdo.comext.
Ken Csaplar is the president of
BDO Capital Advisors and head of the M&A practice. He can be reached at kcsaplar@bdocap.com.to edit this text.