GOOD NEWS for owners of mid-sized companies who thought their window of opportunity to sell had closed for good–the combination of available, competitive debt and equity financing, an interested and large number of buyers and a seemingly resurgent economy is resulting in crowded auctions and higher prices.
In the article below, Stewart Dolin, Esq., presents a persuasive case to sellers for taking action now. Mr. Dolin, a Partner in the Chicago law firm of Sachnoff & Weaver, is Chair of the S&W Business Services Department. A recognized authority on mergers, acquisitions and divestitures; corporate finance; equity investments and alliances and joint ventures, Mr. Dolin is a member of the Chicago Advisory Board of the Entrepreneurship Institute and TEC Worldwide.
The years 1998 through 2000 could well be described as bell-weather times for merger and acquisition activity. At that time, the Dow Jones Industrial Average was trending at an all time high of 11,722 points. Corporate profits were strong and rising. Unemployment rates were relatively low.
At the same time, the number of announced mergers and acquisitions in the U.S. on average exceeded 11,000 per year. Although economic trends in the last several years have been anything but positive, 2004 is shaping up to be the best time in recent history for an active M&A market, one in which mid-sized companies could benefit the most.
Pricing Improves
From 2001 to 2003, when M&A activity remained relatively flat, many previously active buyers were forced to spend a considerable amount of time integrating their acquisitions into their existing businesses, while others were in turn-around mode just hoping their new acquisitions would survive.
Even potential buyers who did not face these problems found it difficult to obtain the debt financing necessary to leverage their equity in order to reach the EBITDA multiples (earnings before interest, taxes, depreciation and amortization) that potential sellers would accept.
As a result, many owners of mid-sized companies abandoned all hope of selling their companies at the prices-typically six-to-eight times EBITDA-they could have received just a few years earlier. Yet despite recent history, there were 5,501 M&A transactions announced during the first and second quarter of 2004. Even better, M&A deals are up across an array of industries, as are EBITDA multiples. Sales of mid-sized companies in particular are receiving some of the best prices in years.
In June, Bob Evans Farms said it would buy Mimi’s Café Inc. for $182 million, including the assumption of indebtedness; a price of over 9 times EBITDA. In February 2004, Sentinel Capital Partners, a private equity firm, acquired Nivel Parts & Manufacturing Co., a maker of golf carts from Koda Enterprises Group, a private investment firm. Sentinel acquired Nivel for approximately $30 million-7 times EBITDA. The creation of this near-perfect selling climate has been the result of a number of confluent factors.
Cheap Debt, Greater Leverage
Currently, debt financing is remarkably low-priced and easy to obtain. The historically low LIBOR (London InterBank Offered Rate) and prime interest rates, coupled with competition between lenders have kept the cost of borrowing low. Mezzanine lenders are facing competition from an attractive high-yield debt market, as well as from an array of new loan products.
Banks have relaxed their requirements for leveraged acquisitions, and banks that had stopped funding buyouts altogether are back in the game again. After sitting on cash during the past few years, many banks are asking buyers for less equity in prospective deals. In 2003, a standard M&A deal often required 35 percent or more in equity from a buyer. Now, that requirement has been relaxed below 30 percent in some cases.
Private equity also is available and relatively easy to obtain. Like banks, prospective buyers have available cash after holding it for several years. Lately, increased stock prices have given leveraged buyout firms more cash either through the sale or extraction of dividends from their portfolio companies. Some industry observers estimate that approximately $100 billion in private equity capital is available for investment.
More Rational Returns
Moreover, just as banks have made it easier for potential buyers to borrow funds, private equity firms have lowered their investment standards as well as their rate of return (ROR) requirements during the struggling equities market of the past few years. Just five years ago, leveraged buyout firms needed to offer investors as much as 30 percent or more annualized ROR on investments. Now, the rates of return often range from the high teens to nearly 20 percent.
In addition, potential buyers not only have available cash, but also are highly motivated to use it. Several buyout funds are nearing the end of their investment period, after which uninvested capital must be returned to the funds’ investors.
More Buyers than Sellers
Today, for the first time in recent memory, there are more buyers than sellers in the market. After lying low for the past few years, corporate strategic buyers have returned to the market. Corporate strategic buyers are those companies that seek to acquire another company because of the operational benefits that will result from the two businesses working together.
Leveraged buyout groups, also known as financial sponsors, are in the market too. Previously, small financial sponsors frequently could not compete with strategic buyers in larger deals. However, having developed effective “clubbing” strategies, where several financial sponsors band together for a one-time deal, financial sponsors are able to compete with strategic buyers for attractive companies.
The increase in the number of buyers also has resulted in much more robust auctions. Several years ago, an auction for the sale of a mid-size company may have attracted three to five participants. But today, there may be 10 or more participants in an auction. One leveraged buyout firm’s recent auction for a company that provides luggage carts at airports attracted more than 50 private equity firms.
It’s the Economy…
Fueling much of this activity is buyers’ confidence in the economy. Improving economic conditions-whether actual or perceived-have potential buyers rushing to get ahead of the market. Analysts are projecting only limited increases in interest rates, increased corporate profits and reduced unemployment for this year and next. As a result, buyers perceive that they can afford to pay more for a company now to take advantage of improved financial performance and stock price appreciation in the future.
The combination of available, competitive debt and equity financing, an interested and large number of buyers and a seemingly resurgent economy have resulted in crowded auctions and high prices. For those owners of mid-sized companies who thought their window of opportunity to sell had closed for good, take note: now may be the time to act. After all, if this seems too good to be true, it may be, the longer you wait.
