The mergers and acquisitions markets were forced to step back and evaluate where they stood following the credit crisis in the second half of 2007. After some introspection, it appears that the market for middle market companies (value < $250 million) remains vibrant. While larger transactions (value > $250 million) suffered due to deteriorating credit markets and company performance (i.e. SLM Corp., United Rentals, Harman International, Acxiom), strategic and financial acquirers still exhibit strong appetites for quality assets. Buyers are on the lookout for companies with good product/service mixes that fill a market need and provide strong cash flow. Financial acquirers flush with cash and strategic buyers with strong balance sheets continue to seek desirable opportunities. While there has been some impact on valuations and debt levels, particularly multiples for acquisitions under $50 million, transaction levels and pricing remain lively. In addition, fears of a recession as well as the recent market correction will affect mergers and acquisitions activity, but will be partially offset by the resulting lower interest rates. Together these factors project an active market for mergers and acquisitions in 2008, although off previous highs.
Year in Review
The first half of 2007 saw sustained high levels of transactions and multiples comparable to the peak periods of the recent boom. However, by summer, the credit crisis was in full bloom, dramatically slowing acquisitions among companies with enterprise values above $250 million. Accompanying the reduction in new large capitalization transactions were numerous high profile cancellations such as SLM Corp. and United Rentals. Large acquisitions and buyouts suffered due to the hefty debt levels needed to complete these transactions. The debt markets’ appetite for these securities was satiated as it was flooded with new issues over the last few years, greatly diminishing the desire to devour additional risk. This contrasts sharply with the middle market.
Transaction Volume and Multiples
The middle market benefited from a multitude of factors including, lower debt levels, limited need to syndicate loans and the continued presence of strategic and financial buyers. It remained active, despite temporary moderation due to the credit crisis. As the table above demonstrates, middle market transaction volume is well within levels seen during 2006 and at, or above, 2004 and 2005 for all value segments. The data also demonstrates multiples are well within the ranges seen during the recent boom. The only exception would be the decrease in multiple for transactions under $50 million in the fourth quarter of 2007. Valuations in this segment remain healthy, but warrant on-going evaluation.
The Year Ahead
In 2008, merger and acquisition activity should remain healthy. Private equity groups still have an abundance of cash that needs to be invested and remain active acquirers. Coupled with the increasing capital levels is the dramatic expansion of private equity firms participating in the middle market. These factors substantially increase competition between acquirers and could continue for the foreseeable future, helping to sustain pricing.
Buyout Capital Raised
Competing with the private equity groups are strategic buyers who continue to seek targets that fill a gap in their product/service offerings, geographic needs or provide platforms for additional growth. Both buyer groups are actively identifying quality assets that provide a path to future profitability. The confluence of buyers will keep acquisition activity strong.
Financial vs. Strategic Acquirers
In addition to these factors, fears of a recession and the debt crisis, which caused the recent market correction, will negatively affect merger and acquisition activity, but primarily the larger, strategic transactions. The Federal Reserve has reduced interest rates in an attempt to maintain a healthy economy. The reduction in interest rates has made money cheap and will help acquirers of all stripes fund acquisitions although the slowing economy should force buyers to be more selective and seek growth through targeted acquisitions.
With the Federal Reserve’s recent actions and expectations that interest rates will remain low, debt will continue to be inexpensive for the foreseeable future. Even with lower interest rates, the buyer ranks may diminish and the credit crisis will cut debt levels that both strategic and financial acquirers can undertake. Certain buyers will be forced to increase the cash or equity needed to consummate a transaction or lower the purchase price. This will impact the multiples that can be paid but will be partially offset by the sheer number of bidders and the lower cost of funding a transaction. Undertaking a comprehensive marketing strategy that includes both strategic and financial acquirers should provide desirable results to quality companies in 2008.