I confess - as a high school kid the rock band Journey was one of my favorites (I will deny ever listening to Cheap Trick and Styx), and Don’t Stop Believing was one of their big hits in 1981. The final episode of The Sopranos (another favorite of mine) played Journey’s song as their own Swan Song. So what does Don’t Stop Believing have to do with anything? It leads me to what some people might argue is a contrarian view in the world of mid-market M&A. For the last 15 years my “day job” has focused on sell-side and buy-side M&A for the middle market. Contrary to popular belief, M&A in my world is alive and kicking.
Also, there are misconceptions in my world. Reports say that valuations have come down considerably – NOT TRUE. Why do I still see activity in the mid-market M&A and healthy valuations? Economics 101 – it is a simple supply and demand issue. There is a continued imbalance of demand outweighing supply. Yes, there is a supply shortage of companies looking for liquidity events. Why? Due to our current economic condition (some may call it a recession) business owners have incorrectly come to the conclusion that it must be a bad time to consider a possible sale of their business. However demand is still strong from both private equity and strategic buyers. With demand still outweighing supply, prices continue to be attractive. Sure they have softened somewhat from the peaks we experienced in the first half of 2007 but by any long term historical measures, price and terms are still robust. So what’s creating the strong demand in the mid-market for private equity? For one it has to do with more and more crowding going on as some of the bigger players are coming down market looking at smaller deals. Couple that factor with a lot of dry powder from all the mid-market funds that raised capital, and you still have too many firms chasing too few deals. Also, the big players have lived through a cycle of having to pay significant multiples to win many auctions. So when they go down market, as much as they want to be more disciplined paying lower multiples for mid-market companies, they often get caught up in the heat of an auction. I guess this should be my “plug” for using a banker and running a competitive process. Its simple - you’ll achieve better terms and pricing by trying to maximize the demand supply imbalance.
In addition to the private equity players' influence on the M&A process, there are many strategic buyers out there who carry just as much weight and sometimes more in an M&A transaction. The strategic players are flush with cash and excess debt capacity and look at “smaller” mid-market deals as easier to integrate, mitigating risks of cultural differences. More importantly, strategic buyers rely on the benefits of cost synergies. And as much as buyers like to tow the party line “we don’t pay for synergies” – they understand that in order to be competitive they have to share in some of the cost savings that they expect to realize. Roll in a few strategic buyers with a long list of likely private equity buyers and, not a surprise, prices continue to be strong.
For me, I don’t stop believing that middle market M&A activity has always demonstrated resilience and healthy activity.
Tom Cibotti is a Managing Director at Covington Associates. He can be reached at 617-314-3950 or ibankerblog@covllc.com.
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