The mergers and acquisitions market will continue to see an uptick in middle-market deals between $10 million and $500 million.
That is the conclusion of Jeff Maxwell, head of mergers and acquisitions at Raymond James. He spoke on “Mergers and Acquisitions Activity in the Middle Market” at the Fifth Annual Liquidity and Capital Raising National Forum, hosted by financial services firm Cohn Reznick and Cohn Reznick Capital Markets Securities on Monday at the St. Regis Hotel in New York. His colleague Jeff Saut, chief investment strategist, spoke on the “State of Middle Market Transaction Activity.” Ezra Lightman, investment banker at Raymond James, Jeremy Swan, Cohn Reznick’s private equity and venture capital industry practice leader, and Daniel Gross of Pegasus Capital Advisors touched upon issues that are the most common deal-breakers.
Noting the appetite on the buy side, Maxwell said deals in the middle market have been “slow and steady,” while in the “last two quarters, deal volume has gone up quite a bit for megadeals.” Megadeals are transactions of more than $500 million.
“Corporate activity is on the rise. Last year, close to 80 percent of the deals were by strategic buyers. That makes sense as they’re been building up cash,” Maxwell said, noting that they’ve been either adding to existing businesses or buying new businesses that can be grown organically.
Private equity on average is about 20 to 23 percent of overall M&A activity, a level Maxwell said represents a “balanced mix between strategic and private equity. That is a healthy M&A market.”
Maxwell said as the “financial markets improve, credit markets have been easy to access, with financial buyers starting to pay up again.” The leveraged buyout debt multiple was 5.7 times in 2007, dropped down to 3 times or so during the downturn in 2009, and is now in the 5.4 range, he said.
Maxwell said U.S. economy is in one of the longest expansion periods ever, and with “north of $535 billion in private equity dry powder and corporations having $2.2 trillion in cash on their balance sheets,” the M&A cycle could continue for some time. That’s because while the U.S. deal market appears “ahead of itself,” once the mega deals are stripped out, what remains is really a moderate picture growth, Maxwell concluded.
Saut said based on his models, he believes the U.S. equity market is in a “secular bull market” that could continue for years. Most last for 14 to 15 years, with the current one having another eight years to go. That would take the S&P 500 to 5,400. He concluded that while the normal timeframe would put the equity market in a late-cycle inning, the downturn was so severe that it has elongated the middle cycle.
Noting six stages of mind-set changes during a secular bull market, the current one is in the “guarded optimism” stage, which follows aftershock and rebuilding. That’s still relatively early in the ballgame, to be followed by enthusiasm and late enthusiasm, and then the exuberance stage still to come before the final stages of unreality and cold water and disillusionment set in.
Saut doesn’t expect a Federal Reserve rate increase in December. “I don’t think it will even happen in 2016,” he said.
“There’s still plenty of liquidity,” Saut concluded, noting that the economy is expected to grow 2 to 3 percent, or what he describes as the “sweet spot of GDP growth.”
Fueling growth will be massive new energy reserves, setting the stage for the U.S. to be a net energy export nation in 2025. Further, there’s a “gigantic amount of capital,” now that businesses have renegotiated their debt. Both set the stage for the U.S. to have “unrivaled manufacturing depth” as businesses to move to the U.S. to take advantage of the abundance of energy and capital, Saut concluded.
As for what could cause deals to break apart, Cohn Reznick’s Swan said the one big factor is the “gap in valuations.” Much of that is due to whether the seller really understands what the business is worth and the expectations of the seller over the sales process.
Gross said he’s looking for sellers who are prepared to stand behind their businesses. They typically want to use forward multiples, or future earnings projections, when valuating businesses, while as a buyer he wants to look at past multiples. He said deals can occur when sellers work with the past multiple valuation and agree to an earn-out once certain metrics are hit.
Raymond James’ Lightman added that deals can unravel during the due diligence period when something comes up that the parties can’t reach an agreement on. Another trip up is when an agreement is contingent on the consent of a third party, which doesn’t materialize, the investment banker said.