As of August, the trailing 12-month M&A deal volumes for the entire U.S. market have steadily increased. However, the aggregate deal values associated with these transactions have increased at an even higher rate over this same period, as can be seen in Figure 1 below. The increase in valuation metrics and deal volumes within the U.S. middle market has played a pinnacle role in the overall U.S. M&A market.
The Middle Market: the Backbone of America’s Economy
Representing nearly 34 percent or $4.3Tii of the U.S. private sector gross domestic product and workforce, middle-market companies are the backbone of America’s economy. As confidence in the economy increases and balance sheets strengthen, middle-market companies are emboldened to shift gears from survival to expansion – a clear and positive indicator for the U.S. corporate sector and the economy overall.
This article discusses the near-term future of middle-market businesses, the strategies these companies are implementing, and the capital expenditures they need to maintain and build momentum. It also explores the current environment for mergers and acquisitions (M&A) and geographic expansion opportunities.
The Shift to Offense
After the recent recession, many middle-market companies implemented conservative financial strategies, such as zeroing in on cost control, managing working capital, increasing liquidity, accumulating cash and divesting non-core assets.
Lately, however, many of these same companies have created and are now executing a more proactive game plan -- shifting from a defensive to an offensive posture by exploring new paths for growth, such as expanding their product offerings.
This shift to offense may be more incremental than game-changing in the short term, considering some top risk-management concerns -- from unanticipated labor costs, including healthcare, to market, operational and credit risks, as well as disaster and succession planning.
Such a swing also requires spending on items ranging from working-capital investment to capital expenditures to the human capital needed to support growth. In 2014, the U.S. middle market is expected to account for 59 percent of all new jobs.
In some cases, companies may be content with moderate growth because they lack the capacity to deal with more robust growth. So how are these middle-market companies achieving and financially sustaining growth?
In a 2014 CFO Outlook survey conducted by a top tier US bank, 94 percent of U.S. CFOs surveyed said their companies intend to implement one or more growth strategies this year. Of those executives, 25 percent are considering a strategic M&A growth strategy, while 59 percent indicated they are considering introduction of new products or servicesiii.
Selling additional existing products or services to current customers (82 percent) and cultivation of new customers or markets (77 percent) rounded out the top growth strategies. By expanding their offerings, companies are leveraging their brand equity to bring something new to customers – yet another indication of rising corporate confidence3.
One-third of companies plan to increase capital expenditures in 2014 to maintain or increase the scope of their operations -- a positive sign for future growth prospects – while 43 percent will keep capital expenditures steady and 21 percent plan to spend less on adding or enhancing fixed assets, according to the CFO Outlook.
Virtually no companies expect to hold off on capital expenditures this year, compared to 8 percent who planned to refrain in 2013. Nearly half of all companies planning capital expenditures (48 percent) expect to acquire or improve fixed assets -- from buying land, new buildings, machinery or vehicles to improving or expanding an existing facility.
Among those companies planning to make an acquisition in 2014, 85 percent expect to buy a competitor, while 28 percent will seek to acquire a supplier and 18 percent a distributor.
M&A can be a catalyst for companies that want to expand globally in situations where desirable organic opportunities may be limited. In many cases, expansion through global or cross-border M&A can significantly speed up a company’s growth path relative to building such presence and capabilities internally. Ultimately, acquiring another company is an aggressive growth strategy that requires both fiscal confidence and strength.
As seen in Figure 3, the period of August 2012 to 2013 had a total of 1930 M&A transactions in the U.S. middle market. For the same period during 2013 to 2014, there were a total of 2041 transactions. This accounts for an increase of 5.75 percentiv in overall middle market M&A activity year-on-year. Approximately 70 percent4 of all middle market M&A transactions are classified as strategic acquisitions.
Geographic Growth Opportunities
While 64 percent of companies pursuing growth in 2014 say it will be all domestic, one in five predict some international expansion along with mostly domestic growth, the CFO Outlook found. Of the remaining U.S. companies, 15 percent believe growth will either be geographically balanced or entirely overseas3.
A broader theme is a “re-shoring” of manufacturing from Asia, particularly China, to North America. The Boston Consulting Group has concluded that rising wages and other factors have steadily eroded China’s once overwhelming cost advantage as an export platform alternative to North America.
Also, factors including declining natural gas and energy costs, higher U.S. worker productivity, and supply chain and logistical advantages may make the production of goods in the U.S. more economical.
Confidence in a Recovering Economy
Middle-market companies returning to an offensive growth strategy to increase their market share in the U.S. and abroad illustrates confidence in a recovering economy. This shift is crucial to the growth of middle market companies.
1 Source: GE Capital. (2014). Leading from the Middle Market. Available: http://visualization.geblogs.com/visualization/midmarket/. Last accessed 9th Oct 2014.
2 Source: US News. (2014). Middle Market Executives Report Bullish 2014 Outlook. Available: http://www.usnews.com/news/articles/2014/07/23/middle-market-executives-report-bullish-2014-outlook. Last accessed 9th Oct 2014.
3 Isabel Fernandez & Thomas A. Stewart. (2014). Middle-Market Optimism Drives U.S. Economic Growth. Available: http://www.thesecuredlender-digital.com/thesecuredlender/june_2014#pg14. Last accessed 9th Oct 2014.
4 Source: Factset. (2014). US M&A News and Trends. Available: https://www.factset.com/mergerstat_em/monthly/US_Flashwire_Monthly.pdf. Last accessed 9th Oct 2014. (Article based upon excerpts from CapitalEyes, Vol. 70, Issue 6, 2014).