By Pat Martin, CFA

MandA-Market-Update-Opportunities-and-Challenges-of-a-Sellers-Market-featureIt’s been more than five years since the economic downturn and market bottom of March 2009, and we’re observing an interesting disconnect between the general economy and the capital markets – particularly the merger and acquisition (M&A) market. With the help of an accommodating fiscal policy provided by the Federal Reserve, the U.S. economy is beginning to show signs of life with a number of indicators finally improving, including gross domestic product (GDP), home prices and unemployment. And while the equity markets have performed admirably with the S&P 500 and Dow Jones Industrial indices at or near all-time highs, few company owners I meet with describe their business as robust, which is why they’re usually surprised to hear it’s a seller’s market from an M&A standpoint. This phenomenon has been created by the simple law of supply and demand and has implications for all business owners, not just potential sellers.

Record Amounts of Capital

Significant amounts of capital have been raised by both corporations and private equity groups specifically to acquire or invest in other companies. Most large public and private corporations, also known as “strategic buyers,” have seen their business improve more quickly than their smaller competitors and are in a strong financial position. The companies that comprise the S&P 500 (excluding banks and other financial services firms) are experiencing record earnings and have in excess of $1.5 trillion of cash on their balance sheets. Additionally, they have access to considerably more capital through the credit markets, which remain inexpensive with short-term interest rates still near zero. Given the limited opportunities for internal or organic growth, acquisitions present a potentially attractive alternative to enhance shareholder value. In fact, many large corporations tell us they expect acquisitions will represent 50 percent or more of their growth going forward.

Private equity groups or “financial buyers” are dedicated funds raised by investment professionals (the general partners) from a variety of institutional sources, including pensions, endowments and family offices (the limited partners), seeking an enhanced return from an alternative asset class – in this case, a nonpublic equity. The general partners who manage the funds make either majority (control) or minority (non control) investments in businesses with the capital typically used for shareholder liquidity or growth funding. The financial buyers’ challenge is complicated by the need to put their money to work in a finite period of time. A fund generally has a 10-year life to both invest and realize its investments. Many funds that were raised at the top of the market in 2006-2008 still have not invested all of their proceeds, and the general partners have an economic incentive to do so. As a result, we’ve seen private equity bid extremely aggressively for quality assets as they attempt to put money to work ahead of their internal deadlines. We estimate the private equity community currently has in excess of $380 billion in undeployed capital or “dry powder,” which represents close to $1 trillion in buying power when their use of leverage is included.

Impact on Your Business

Given the massive amount of capital looking for a home, there simply aren’t enough companies for sale to satisfy the demand. This dynamic has frustrated even the most seasoned buyers because it has made it difficult to be the winning bidders, even when they’re aggressive on pricing. For an inexperienced buyer, the likelihood of success is even lower. In today’s competitive M&A environment, a first-time buyer will have a hard time prevailing in any type of auction-oriented sale process, and in the event they do, they’ll likely pay more than originally anticipated, increasing the risks associated with post-closing integration. Companies without pressure to participate should avoid auctions and focus on potential targets they have existing relationships with as well as a strong strategic and cultural fit.

Even owners who don’t have an M&A plan would be wise to be mindful of how market activity can affect their business. While they are rightfully focused on the daily challenges of running a company and serving their varying stakeholders, including customers, employees and shareholders, it’s important to remember in business, there is no such thing as status quo – or, if there is, it’s temporary at best. For example, mergers can quickly change the landscape of an industry. The combination of two strong players can create a more powerful competitor or limit another company’s opportunities for future growth. Conversely, if competitors attempt a merger and fail in the execution, it may result in presenting other companies with customer opportunities that didn’t previously exist. Remember: just because you’re not participating doesn’t mean M&A activity won’t affect your company’s future.

Good Time to Be A Seller

If your plan happens to involve some form of near-term sale, recapitalization or liquidity event – congratulations, your timing is great! We’ve seen unprecedented demand for our sell-side clients, with valuation multiples at or above levels last seen in 2007 for most industry sectors. The number of business owners contemplating strategic alternatives is increasing, and we expect many will come to market to take advantage of the current supply-demand imbalance. Barring an unexpected shock to the economy, we believe M&A activity will accelerate in the next few years, and while we can’t know with certainty how long it will last, we do know it can’t last forever.

By Pat Martin, CFA

MandA-Market-Update-Opportunities-and-Challenges-of-a-Sellers-Market-feature

It’s been more than five years since the economic downturn and market bottom of March 2009, and we’re observing an interesting disconnect between the general economy and the capital markets – particularly the merger and acquisition (M&A) market. With the help of an accommodating fiscal policy provided by the Federal Reserve, the U.S. economy is beginning to show signs of life with a number of indicators finally improving, including gross domestic product (GDP), home prices and unemployment. And while the equity markets have performed admirably with the S&P 500 and Dow Jones Industrial indices at or near all-time highs, few company owners I meet with describe their business as robust, which is why they’re usually surprised to hear it’s a seller’s market from an M&A standpoint. This phenomenon has been created by the simple law of supply and demand and has implications for all business owners, not just potential sellers.

Record Amounts of Capital

Significant amounts of capital have been raised by both corporations and private equity groups specifically to acquire or invest in other companies. Most large public and private corporations, also known as “strategic buyers,” have seen their business improve more quickly than their smaller competitors and are in a strong financial position. The companies that comprise the S&P 500 (excluding banks and other financial services firms) are experiencing record earnings and have in excess of $1.5 trillion of cash on their balance sheets. Additionally, they have access to considerably more capital through the credit markets, which remain inexpensive with short-term interest rates still near zero. Given the limited opportunities for internal or organic growth, acquisitions present a potentially attractive alternative to enhance shareholder value. In fact, many large corporations tell us they expect acquisitions will represent 50 percent or more of their growth going forward.

Private equity groups or “financial buyers” are dedicated funds raised by investment professionals (the general partners) from a variety of institutional sources, including pensions, endowments and family offices (the limited partners), seeking an enhanced return from an alternative asset class – in this case, a nonpublic equity. The general partners who manage the funds make either majority (control) or minority (non control) investments in businesses with the capital typically used for shareholder liquidity or growth funding. The financial buyers’ challenge is complicated by the need to put their money to work in a finite period of time. A fund generally has a 10-year life to both invest and realize its investments. Many funds that were raised at the top of the market in 2006-2008 still have not invested all of their proceeds, and the general partners have an economic incentive to do so. As a result, we’ve seen private equity bid extremely aggressively for quality assets as they attempt to put money to work ahead of their internal deadlines. We estimate the private equity community currently has in excess of $380 billion in undeployed capital or “dry powder,” which represents close to $1 trillion in buying power when their use of leverage is included.

Impact on Your Business

Given the massive amount of capital looking for a home, there simply aren’t enough companies for sale to satisfy the demand. This dynamic has frustrated even the most seasoned buyers because it has made it difficult to be the winning bidders, even when they’re aggressive on pricing. For an inexperienced buyer, the likelihood of success is even lower. In today’s competitive M&A environment, a first-time buyer will have a hard time prevailing in any type of auction-oriented sale process, and in the event they do, they’ll likely pay more than originally anticipated, increasing the risks associated with post-closing integration. Companies without pressure to participate should avoid auctions and focus on potential targets they have existing relationships with as well as a strong strategic and cultural fit.

Even owners who don’t have an M&A plan would be wise to be mindful of how market activity can affect their business. While they are rightfully focused on the daily challenges of running a company and serving their varying stakeholders, including customers, employees and shareholders, it’s important to remember in business, there is no such thing as status quo – or, if there is, it’s temporary at best. For example, mergers can quickly change the landscape of an industry. The combination of two strong players can create a more powerful competitor or limit another company’s opportunities for future growth. Conversely, if competitors attempt a merger and fail in the execution, it may result in presenting other companies with customer opportunities that didn’t previously exist. Remember: just because you’re not participating doesn’t mean M&A activity won’t affect your company’s future.

Good Time to Be A Seller

If your plan happens to involve some form of near-term sale, recapitalization or liquidity event – congratulations, your timing is great! We’ve seen unprecedented demand for our sell-side clients, with valuation multiples at or above levels last seen in 2007 for most industry sectors. The number of business owners contemplating strategic alternatives is increasing, and we expect many will come to market to take advantage of the current supply-demand imbalance. Barring an unexpected shock to the economy, we believe M&A activity will accelerate in the next few years, and while we can’t know with certainty how long it will last, we do know it can’t last forever.

 

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About the Author

Patrick Martin

Patrick Martin

Managing Director, Head of Strategic Advisory Group, BB&T Capital Markets

Patrick joined BB&T Capital Markets in 1998 and has advised middle-market clients throughout a variety of industries in mergers & acquisitions, as well as public and private offerings of debt and equity securities. He founded BB&T Capital Market’s Strategic Advisory Group in 2009. Patrick holds a bachelor’s degree in business administration from The College of William & Mary and an MBA from the Graduate School of Business at William & Mary. He is also a CFA® charter holder.