Supply-demand economics in sellers’ favour in the Canadian private mid-market
Building on the strength of several years of an improving deal-making ecosystem, our view is that 2015 should set another high-water mark for a majority of mid-sized private companies in Canada looking to sell. Some business sectors, such as oil & gas field services, may miss out on the proverbial party for obvious industry-specific reasons.
To understand why we believe great things are in store for 2015, we examined data from private equity (PE) deals in the US and Canada (from Pitchbook). The cross-border nature of the North American (NA) PE landscape makes the NA trends a good barometer for Canadian M&A activity in the private mid-market.
How strong are valuations?
Valuations have generally increased across industries, though some sectors have been favoured by buyers more than others. Multiples paid for Technology companies have skyrocketed in the past five years, well above the long term average of 6.8x Total Enterprise Value (TEV) / Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) for the sector.
Similarly, valuations have improved as a function of deal size. For example, a $100 – 250 million deal concluded on average at 6.4x in 2010; in 2014, it transacted at 7.7x, more than a full turn of increase in EBITDA. Deals of less than $25 million have yet to see meaningful change in the multiples paid for them, but we believe this is where most of the growth should come from in 2015.
What factors are driving this broad multiple improvement?
The answer is explained by simple supply-demand economics in the middle market: as can be seen in the chart to the right, there are fewer and fewer quality targets for PE firms (number of transactions has not recovered to 2007 levels), despite there being more PE ‘dry powder’ available than ever before.
Specifically, we single out five factors at play:
- COMPETITION FROM STRATEGIC BUYERS.
The aggregate cash that North American public companies, who are better acquirers than ever before in terms of their ability to realize value, is in excess of $5 trillion. Acquisitions are one obvious way to use this cash.
- PE IS FLUSH WITH CASH.
Similarly, mid-market focused PE funds are now sitting on a near record $121 billion in cash that must be deployed quickly.
- ECONOMIC RECOVERY IN US.
As a result of the accelerating US economic recovery, PE buyers are more confident in their portfolio companies’ growth prospects, which they seek to ‘fast track’ through add-on acquisitions.
- STRONG DEBT CAPITAL MARKETS.
Senior and junior debt for M&A (see chart) remains favourable with low interest rates, higher availability and looser covenants for borrowers. GF Data estimates the debt used in transactions to have increased to 4.8x EBITDA in 2014, up from 3.3x in 2009.
- A SCARCITY OF SELLERS.
After five years of steady growth in M&A activity, competition for good deals is intensifying and pushing up prices paid for those. However, we would not be surprised to see the remaining ‘eligible’ sellers put their company up for sale in the coming months, at last realizing that the good times may not last that much longer.