Banking & Finance and Opinion

CONNER: Uncertain times in the merger and acquisition market

August 4, 2012

ConnerDealmakers are in a period of unprecedented uncertainty. Several factors are contributing. Here are questions I get.

How is overall deal flow?

While the overall number of deals getting completed has rebounded nicely from the near all-time lows of 2008 and 2009, the first quarter of 2012 was a mixed bag. As the number of deals announced in the United States increased 7.1 percent over a year earlier, the disclosed dollar volume of those deals actually declined 38.1 percent.

In addition, the number of U.S. middle-market deals (less than $750 million in transaction value) was actually down 16.5 percent. Middle-market deal value was also down 6.2 percent. My guess is that the second quarter was not much different from the first.

Verdict: Deal flow is fair at best.

What about multiples?

The answer varies widely and depends on a range of factors, including deal size, industry sector, sales and profit momentum, and profit margins. What I can say with some certainty is that deal multiples have returned to their pre-downturn levels.

If a company would have sold for six to seven times earnings before interest, taxes, depreciation and amortization in 2005 but only at four to five times EBITDA in 2009, that same company would now probably sell for somewhere around six to seven times EBITDA.

Verdict: Multiples are back to pre-downturn levels and are relatively robust.

Is it a buyer’s or seller’s market?

There is still a good deal of private equity money on the sidelines that needs to be invested. Private equity and mezzanine funds that raised money in 2005, 2006 or 2007 went through a drought in 2008 and 2009 when fewer businesses were for sale. They now need to put that money to work.

In addition, strategic buyers, such as corporations, have a lot more money at their disposal to do deals as they’ve gotten additional wind in their sails. Most of the private equity groups we interact with seem to be much more focused on selling companies and doing add-on acquisitions than on adding new platforms.

Verdict: It’s definitely a seller’s market.

How are deals getting financed?

The amount of equity needed to finance a deal seems to be higher than before the downturn of 2008-2009. Before the downturn, many private equity deals were getting done with 30 percent to 40 percent equity. That percentage is now probably closer to 40 percent to 50 percent. This is a function of the amount of debt available to finance deals and the fact that many investors are just not willing to leverage their investments as aggressively as they were.

Verdict: Deals are getting financed with more equity and less debt.

Any trends in lending?

While lenders are back in the market, overall leverage multiples are not as high as they were pre-downturn. This is driven by tighter control by banking regulators on “highly leveraged” transactions. On larger transactions, total senior bank leverage is capping out at around four times EBITDA while total leverage (including mezzanine and seller debt) is typically capped at six times EBITDA.

Most middle-market deals are maxing out pricing at around 3.5 times, and 5.5 times for senior and total debt. Interest rates are still at or near all-time lows.

Verdict: Banks are lending and interest rates are low; however, leverage multiples are relatively average.

What about the election?

The difference in philosophies between the presidential candidates is as wide as I can remember.

Verdict: High uncertainty about the election has convinced many business owners to hold off on doing anything.•

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Conner is a managing director for Periculum Capital Co. LLC, an Indianapolis-based investment and merchant banking firm. Viewpoints expressed here are the writer’s.

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