At a time of international market uncertainty and slow economic growth, I have been curious as to why the market for buying companies is so robust.
I posed the question to experienced deal adviser Pirooz Pourdad of PwC.
“It’s simple,” he said. “Demand is extremely high. There are a number of macro factors all coming together at the same time that are contributing to a strong seller’s market.”
The first one is counterintuitive. Organic gross domestic product (GDP) growth is slow. Large corporations are struggling to increase per-share earnings in this environment. So how can companies satisfy their shareholders’ need for share price appreciation and dividend growth? They are buying to accelerate growth.
Mature companies are buying niche players to defend and extend market share. A recent example in the food and beverage industry was the $550 million cash acquisition of Sequel Naturals, the maker of Vega shakes and bars, by WhiteWave Foods Co. at a 5.5-times-revenue multiple. This is an example of a strategic buyer reacting to a changing market, trying to find a brand that will attract millennial consumers, with a healthy food offering.
In the technology industry, a recent and local example was Match Group’s $575 million cash acquisition of PlentyOfFish.
The second factor, according to Pourdad, comes from the investment supply side. There is, he said, a “massive amount of dry powder on the books of private equity funds and on the balance sheets of corporations that is not earning a sufficient return.”
According to John Gabbert, CEO and founder of PitchBook, a service that tracks deal flow, “after seeing a record $574 billion in North American dry powder in 2013, private equity firms still have a staggering $550 billion left to deploy.
“That, coupled with post-crisis records in both deal counts and capital invested in the U.S. middle market, indicates that there are plenty of buyers and dry capital in the market.”
In 2015’s first half, there were around 1,100 middle-market transactions worth $140 billion, equal to 2014, and the most active since 2007.
In many cases, private equity funds are making add-on acquisitions to platform companies, thus behaving like strategic buyers, who typically pay more for the value of synergies. With the right adviser, the seller should get paid for some of this synergy value.
Using debt to fund acquisitions is cheaper than it has ever been in modern history. Conventional debt, after accounting for inflation, is almost free and can supercharge returns.
For example, if I buy a company that makes $4 million in earnings before interest, taxes, depreciation and amortization (EBITDA) for $20 million, paying a five-times EBITDA multiple, in simplistic terms I am getting a 20% return. If instead, I borrow 50% of the money at a 4% interest rate, I will pay $400,000 in interest and pocket $3.6 million, with only $10 million invested, boosting my equity return to 36%.
Access to widely available leverage in the U.S. is pushing deal multiples up to an average of 10 times EBITDA, approaching the historic highs of 2007. The availability of leverage is trickling down to the lower middle market, which is driving up competition and raising valuations. Further, buyers are being very co-operative in getting deals done.
The final fuel to the fire, according to Pourdad, is the globalization of technology. Buyers are not scared of crossing borders or time zones, because they can manage companies from afar much better than in the past. This opens up the potential market to American, European and Asian buyers.
Does any of this apply to smaller companies or is it just for the big end of town?
Pourdad said the logic applies to all companies; however, size matters when it comes to dealing with private equity firms, most of which want to look at businesses with EBITDA greater than $5 million.
“The proportionate value of the benefits gets better if the company is bigger. However, for smaller companies, management buyouts are more viable today because of the availability of financing. When prime is just 2.7%, senior debt and subordinate debt or mezzanine finance is much more affordable.”
With the market this strong, business owners should be prepared in advance, rather than simply reacting when approached.
If you are interested in hearing more about buying and selling companies, join me as I moderate the Association for Corporate Growth’s state of the markets panel on September 22, at the Hyatt Vancouver. Check out www.acg.org/bc for details. •
Robert Napoli ([email protected]) is vice-president of First West Capital, a division of First West Credit Union that finances acquisitions, buyouts and growth. He is also past president of ACG British Columbia, an association for deal-making and corporate finance professionals. His column appears monthly in Business in Vancouver.
