Firmex recently released a study with Mergermarket on the state of North American mid-market M&A. As Forbes noted in a response piece, it showed that deal flow is down but there’s plenty of reason to be optimistic for the future in a number of areas. In private equity, while firms are feeling pressure from strategic buyers right now, there’s a huge amount of capital waiting to get deployed once they adjust to the new landscape. And one of the factors dominating this new landscape will be the baby boomer generation reaching retirement and selling their businesses.
In order to examine these trends and make some sense of how they’re playing out on the ground, we spoke with Kevin Ramiser, an M&A advisor with Vesticor.
Just to start things off, what’s the biggest trend you’re seeing that has characterized mid-market M&A this year?
It’s really been the year of the strategic mega-deal. If you look at how they’re driving valuations, we’re seeing more and more of that. The stock prices in the first half of the year were pretty high. We’ve seen a lot of stock for stock deals.
So when you look at the bigger deals, they’ve primarily been done, at least this year, because of tepid top line growth. These companies are searching for acquisitions to ignite the top line revenue growth. And we’re not seeing them done specifically, as they have been in the past, for cost savings or synergies. What they’re asking is, how do we ignite revenue growth? We have an iconic brand with slowing sales. How do we go after a different consumer base? And we’ve seen these drive valuations higher, which has really left private equity out of the picture.
So you agree with the report’s findings, that PE has been less active this year?
They have in the past been very active in the mid-market, but they’ve really been kind of the wallflowers in global M&A deal making this year. Around 5% of the announced deals have been private equity, that’s the lowest percentage for any kind of similar period in about 14 years now. I think back to around 2006 when in the headlines, every single week or month it was Blackstone Carlyle, or KKR – you know, their headlines making deals. And Private Equity accounted for over 20% of announced deals.
Why do you think that is?
PE firms obviously have a huge amount of cash, but they’re having a difficult time competing with strategic buyers, even in the mid-market space. And a lot of the private equity firms we talk to are having to go downstream and look at businesses that fall outside of their specialty areas that they’ve been known for over the years. On top of that, they’re also expecting longer holding periods. So I think we’ve had this kind of stall period where they’re redefining how they value, model and do their due diligence within companies.
On top of that, last year was a massive year for PE exits. The LPs are kind of pounding the table. They have the lowest exposure they’ve had to PE in a long time because of these exits, and they’re just under exposed to that sector now. These funds have to get deployed eventually, and we’re going to start seeing that happen soon.
With longer holding periods, is a major factor that PE firms are too slow?
For now, I think it’s a factor. I also think that PE companies are finding that they have to compensate for new due diligence standards that present new threats. Things like cyber security risk and regulatory changes. So there’s this new framework that PE firms have to use to value companies before they make a move. I think they’re still going to have some difficulty going forward – they’re still going to have to compete with strategics out there.
But that said, I think they’re going to ramp it up. They’re going to have to. They have assets under management that need to get deployed. They’re going to have to reset some of their holding period expectations, but they will eventually participate. Right now we’re seeing them digest that and I think there will be a massive deployment of capital when they’re ready.
What about the report’s claims on demographics – are you seeing this on the ground? Is the aging population having a tangible effect on deals?
Demographics are a big factor that a lot of publications aren’t talking about. What Cornell Wright mentioned in the report about baby boomers, I’m hearing more and more of that. In the last six months, we’ve been pounding the table. We need to get in front of this. There’s a huge wave coming, particularly in the mid-market where businesses are more closely held. I’d estimate that 50% of the ownership in these businesses will transition into retirement in the next decade.
So how do we help them when we work with mostly lower mid-market companies? We see this all the time. There’s a closely held business, and there’s really no succession plan. What they’re looking for are buyers so that they can go off into the next chapter of their life. Most of their net worth is tied up into these businesses, and they want to monetize the value of their life’s work. They’re in their 60s, 70s in some cases. They’ve worked longer. They’ve built a great business. We’re seeing this in many, many industries, and it’s a big challenge.
What do you think will be the effect of this?
You’re going to see a lot of these businesses hit the market which – you know, basic economics – it could affect valuations. But I do believe that with all this money on the sideline, particularly with private equity, and the demographics shifting as they were, it’s going to be interesting to watch. Even in the short run, over the next three to five years as more of these companies come to market, it will appeal to the private equity side. I think they’re going to have competition amongst themselves going after some of these companies, and I don’t see that slowing down.
Are there any other major trends you’re seeing that aren’t mentioned here?
This is probably for larger deals, but we’re seeing activist hedge funds become a bigger, bigger part of M&A that they haven’t in the past. They’ve really gained a lot of support from large institutional investors. And although they’re small – they represent about $250 to $300 billion – but we are seeing them– they are getting more capable of pressuring companies to either spin off a division that they don’t like, or go after a specific target. So they’re having a bigger role in M&A. We’re seeing more and more of it – these activist hedge funds come in and start calling the shots from an M&A perspective.
Another issue that I always talk about that a lot of people don’t address is we see mid-market deals happen in response to changing consumer behaviors. I talk about this all the time, and it seems to fall on deaf ears. But the middle market tends to kind of grab this change so much sooner than larger companies. So whether it’s in the way people get their news, or the way they’re eating healthier, this affects bigger companies as some of these smaller companies start taking market share from them. So we’re seeing these middle market companies really meet the needs of these changing consumer behaviors, and that can really affect iconic brands. We’re seeing companies say, we need to be in this market – this growing part of the business that could redefine our business over the next 10 years – that’s growing at double digit growth rates versus our core product growing at single digit growth rates, we need to make an acquisition in that market
Thanks for talking with us – it’s going to be interesting watching how this plays out across 2016.
It definitely will. Thank you, too.