At first glance, 2015 was a stellar year for global M&A, with total deal values reaching a record high and EBITDA multiples touching levels not seen since 2007. However, the underlying data points to a less optimistic outlook for some segments of the market. Of concern to FirePower and its clients, deal amounts and volumes in the North American mid-market (defined as deal value <$1bn, all values in USD) both declined by 8% in 2015 and the number of transactions dropped to the lowest levels in almost 40 years in the first month of 2016. Thomson Reuters reported that this January saw just 121 mid-market transactions close in North America, the lowest total since 1978 and a 50.2% decline compared to January 2015’s total of 241.
In this issue of FirePower’s Market Insights, we investigate the current mid-market M&A environment in North America and look for similarities between the markets now and previous M&A super cycles. By understanding the impact on both buy- and sell-side transactions in the event of increased market volatility, management teams can better prepare and increase their chances of a successful transaction in spite of rapidly changing dynamics.
The Ending of a Cycle?
The health of an M&A cycle, from a purely transactional viewpoint, is measured by two metrics: value and volume. In periods of positive activity, both these drivers are usually increasing: as deal activity (volume) increases, so does competition, driving up purchase multiples and in turn, the total deal value. And as multiples increase, so does the number of transactions, as buyers are concerned that the increase will continue and sellers aim to lock in high valuations. The opposite is also true: as volume dries up and buyers become scarce, sellers have to lower their price to transact. Similarly, as multiples decline, it is less attractive for business owners to sell and buyers may wait for the price to fall even further.
As mentioned, we began to see both these M&A cycle drivers turn negative in 2015 after steadily improving since 2009 and have continued to decline to start 2016. This downturn comes after a period of strong growth: 2014 values were the highest since 2007, volumes were the largest since 2008 and EBITDA multiples peaked at 10.5x, levels unseen in recent times. The slowing volume and values in 2015 warrants further attention: declining environments following periods of peak values are often not “one-offs” and a further market correction is likely, which adds additional risk (i.e. timing) for any company looking to buy or sell.
Looking back at the end of the last M&A cycle highlighted a similar situation: values and volumes in 2007 saw record highs before dropping 66% and 43% respectively, by 2009. In fact, the parallels between the recent market conditions and 2007 are eerily similar and extend beyond peak multiples, values and volumes: both periods also saw strong economic growth during the preceding years, the S&P 500 was and has been setting new all-time records, and recent US jobless claims are hitting lows not seen since 2007. If January 2016’s results are an indication of things to come, we may be in for a volatile period for North American mid-market M&A; however it is highly doubtful we will see a broad and sharp meltdown as severe as 2008/2009.
Sell Now, Buy Later
Although a full global decline is unlikely, we may still be seeing the end of an M&A super cycle, leading to declining multiples in the years to come. For companies thinking about selling within the next few years, securing a higher multiple now may result in a higher overall valuation, even for companies with a strong growth forecasts in the near-term. For example, an EBITDA multiple contraction from 9.0x to 5.6x over three years, like we saw from 2007 – 2010, offsets an annual EBITDA growth rate of 17%, an envious rate for most. Even ignoring a potential decline, transacting at near-peak multiples is seldom a bad decision.
Of course the opposite is true for acquirors; waiting to transact may significantly reduce the total purchase price in a declining multiple environment. Companies who can afford to be patient could delay, continue to build their warchest, and buy more for less in a few years.
How Do I Capitalize On Peak Multiples?
Companies looking to crystallize the current, near-record valuations should prepare their business for sale, providing optionality in case the opportunity to transact arises. Accountant-reviewed financial statements, at a minimum, from a reputable accounting firm, a 2016 and 2017 forecast and stable (or explainable) normalized cash flows are core components. Additionally and more importantly, understanding the M&A conditions in your specific industry and geography is critical.
Knowing the multiples at which a business could transact allows management teams to make informed decisions and determine whether the valuation levels are attractive enough for shareholders.