Middle-market Buyers Ready to Pay More for Quality Deals
Although the volume of middle-market M&A deals fell in Q2 of 2011, the value of the deals that did go through increased, suggesting that firms with healthy cash flow will not meet a shortage of buyers in the second half of the year.
Deloitte’s Middle Market M&A report published in August 2011 found that total leverage multiples rose from an average of 4.0x in the first quarter of the year, to 4.6x in the second quarter.
Deloitte suggested that there are several reasons for the increase in value, not least the fall in the number of deals coming to the table. The lower deal flow has led to greater competition for those that do arise, which in turn resulted in more aggressive transaction structures, according to Deloitte’s analysts.
The deals perceived to be of the highest quality – where healthy firms with strong cash flow are involved – have also attracted larger equity contributions from buyers, with the average rising from 33 per cent in the first quarter of 2011, to 42 per cent in Q2.
Since 2009, there has also been a return of financial buyers to middle-market merger and acquisition activity, which has helped drive the rise in multiples paid for businesses. Private equity is looking particularly strong with 68 new PE funds closing in the first half of the year, which represents $50 billion in capital.
Although the volume of deals fell in the second quarter of the year, the overall outlook for middle-market M&A is positive. Some 35 per cent of middle-market companies said they wanted to be involved in acquisition activity in the year to come, while 15 per cent said they wanted to be involved as a seller.
Growth is of course the main driving force behind the decision to embark upon mergers and acquisitions and a survey of the middle market carried out by Economist Intelligence Unit (EIU) found that 81 per cent of chief executive officers and executives questioned said they expected their firm’s revenues to increase over the course of 2011. Some 59 per cent expected profit margins to rise above pre-recession levels by 2012 and almost 70 per cent plan to recruit additional full-time staff.
The sector is not without its challenges of course, and many of the CEOs questioned named factors such as US government debt, regulatory issues and poor consumer confidence levels among the problems they are currently facing. However, research indicates that the middle-market sector – often regarded as America’s “economic engine” – is faring well, with many firms reporting increased capital accumulated as a result of frugal behavior during the recession. These businesses want to spend this cash on growing their companies and the search for quality deals has become a priority strategy for many.
With regards to the higher prices being paid for these quality deals – this is also likely to continue, perhaps regardless of whether the volume of deals available increases. Thomson Reuters’ Middle Market Lender Survey discovered that well over half (58 per cent) of respondents said they were comfortable with leverage multiples of over 4.5x, while almost all the remainder said they felt comfortable with leverage of over 4.0x.
In conclusion, buyers can expect an increase in quality deals coming to the table in the remainder of the year, so long as the middle-market continues its promising recovery. Meanwhile, sellers will be happy to learn that they can expect to receive higher prices for their businesses, providing they can demonstrate strong cash flow and healthy growth potential.
