We are apparently heading ‘Back to the Future’ based on the first quarter M&A transaction results of 2008. While merger and acquisition activity is down in both value and volume over the last twelve months, when compared to 2004 the activity remains quite respectable. However, the trend over the last four quarters would indicate that we could see a further drop in M&A activity. The general consensus is that we are either in or headed into a recession (data released this week indicates a modest 0.6% growth rate for 1st quarter 2008). The sub prime mortgage contagion continues to spread; foreclosures are up; banks are scrambling for new capital; access to loans is restricted; all of this is forcing nearly everyone to pause.
Market Activity The data indicates that strategic buyers were clearly the dominant market force in the first quarter, accounting for more than 91% of all transactions that were announced or completed. This is the highest level since Q1’04 and continues a trend that first emerged in Q3’07. Companies are utilizing strong balance sheets that have helped this group reassert themselves in the market. According to a recent Bloomberg article the non-financial S&P 500 firms are sitting on a stockpile of $615.5 billion in cash providing them with ample resources to execute deals. The substantial financial resources of these companies combined with potential synergies, support payment of higher multiples. While strategic acquirers historically have always had this advantage, they’ve not been as competitive in recent years due to the high leverage multiples private equity groups were able to undertake.
Financial vs. Strategic Acquirers
Source: CapitalIQ / Thomson Financial
Private equity groups remain an active component in the market but are less aggressive due to the current lending environment. Lenders are applying tighter restrictions on credit and remain reluctant to match the cash flow lending they have previously allowed. The exceptions are companies with substantial assets. Lenders line up to provide debt to these companies, creating an interesting dichotomy. The restricted lending parameters has forced private equity groups to either increase the equity component, decrease debt levels or subsequently lower valuations in order to achieve return expectations. Although PEGs have not been as active recently they are certain to be enthusiastic participants in the near future. London-based Private Equity Intelligence Ltd. reported that private equity firms raised $163.5 billion in the first quarter of 2008, the second highest total since this group started tracking the data in 2003.
Improving Valuations? It appears that the lower multiples private equity groups typically may pay have been offset by strategic buyers. Valuations have improved over Q4’07 in the middle market in most segments and remain healthy in all segments, supporting the thesis that buyers are willing to pay for quality. However, the jagged movement of the multiples makes it difficult to spot trends. The most notable increase is among companies with valuations below $50 million. EBITDA multiples improved from 7.9x to 8.7x during Q4’07 to Q1’08. The most notable decline was in the $50 million to $99.99 million segment which decreased from 11.7x in Q4’07 to 8.1x in Q1’08.
Transaction Volume and Multiples*
*Historical data subject to change as transactions are cancelled or revised Source: CapitalIQ
The data suggests a healthy demand for middle market companies still exists. While current activity is being tempered by the concerns listed above all buyers are still actively seeking acquisitions. The market should remain busy as long as these groups have the capital and capability to undertake these transactions, let’s hope so!