The Global Economy

Compared to the strength of foreign currencies, the weakening U.S. dollar is creating compelling investment opportunities for overseas buyers, particularly from Europe, the Middle East and India. With the rise in overseas buyers, some U.S. business leaders express concern that foreign acquisitions could threaten national security. However, in 2008, middle market companies should embrace, not fear, international investors. International investments are mutually beneficial both for the middle market American company and the overseas buyer.

The U.S. dollar – and economy – will stabilize by encouraging overseas investments, and thus, help offset the looming predictions of a 2008 recession. Despite 2008 recession predictions, 64 percent of U.S. middle market companies with revenues between $25 million and $1 billion are expected to grow in the next 12 months according to a study from the Economist Intelligence Unit and CIT Group, Inc.

What is the driving force behind 2008 middle market growth? It is the same force that has revived Fortune 500 companies: foreign acquisitions. The additional capital being supplied by stable, deep-pocketed overseas investors allows promising U.S. companies to pursue attractive growth opportunities. In many cases, international buyers are the ideal acquirer for U.S. middle market companies for the following distinct reasons:

·         Foreign investors are willing to pay excellent premiums as they are using the relative valuation of the U.S. dollar to their advantage

·         Many foreign companies want to enter the U.S. market with a strong presence, and the best way to enter is through an acquisition of an existing American company

·         Like U.S. executives, foreign executives understand that many business processes are ingrained in our society, and they are more likely to be attracted to existing U.S. management that will remain in place after the acquisition

With the weak U.S. dollar, FOCUS has witnessed firsthand the tipping point of our new global economy and predicts that European and Indian buyers are most likely to lead in the purchase of U.S. companies during 2008 and beyond.

1. European Buyers

The weakening U.S. dollar has resulted in more European buyers purchasing U.S. companies. For middle market companies, exchange rates greatly impact the M&A marketplace. Compared to the Euro, the imbalance of the U.S. dollar has created enormous opportunities for foreign buyers in numerous ways, and as a result, U.S. companies have become likely targets for European buyers seeking to take advantage of their currency’s immediate buying power. At FOCUS, this trend is evidenced by the fact that seven out of the last 20 FOCUS transactions involved Western European buyers.

2. Indian Buyers

With the continuous decline of the U.S. dollar value, the U.S. remained the favored hunting ground for Indian firms in 2007. According to The Wall Street Journal, Indian firms concluded 125 deals in the first half of 2007. Of those 125 deals, 70 were completed in markets outside India. Again, FOCUS is experiencing this trend firsthand as the firm assisted Dunn Solutions Group in its sale to Cranes Software International, an Indian firm. In 2008, this trend is expected to continue providing U.S. companies with another very attractive group of buyers.

Changing Demographics

3. Retiring Baby Boomers

There are 78 million baby boomers in the United States – the largest population segment in America. According to the Exit Planning Institute, more than 8 million privately held U.S. companies will be sold by baby boomers seeking retirement in the next 12 to 15 years. In 2001, 50,000 baby boomer business owners retired, while 750,000 are expected to retire in 2009 according to NFO World Group.

The vast number of companies for sale should inherently reduce purchase prices due to simple supply-demand economics. Some sellers will want to stand out in the crowd, planning and executing their exit strategy now, providing early market entrants with a more attractive supply and demand environment.

As baby bloomers plan their exit strategies, many second- and third-generation family-owned businesses are not staying in the family. This is occurring for two reasons:

·         Current business owners do not have children for passing down the business.

·         Children of retiring business owners are opting for alternative careers.

According to the Family Firm Institute, only 33 percent of U.S. business owners will successfully transfer their family business to the next generation. Thus, two-thirds of business owners with or without children have life-changing decisions to make, and many will opt to sell their businesses domestically or internationally.

Meltdowns and Slowdowns

4. Residential Construction Meltdown

The residential construction meltdown has not only affected the residential real estate industry, but the impact is now seeping into the commercial real estate industry as well. All industries servicing construction and real estate development have fallen out of favor with the bursting of the housing bubble.

5. Subprime Credit Meltdown

While Americans continue to hear about and feel the subprime credit meltdown ramifications, we believe financing in the middle market arena will be available in 2008. Private equity firms, which have become a large part of the lower middle market in recent years, are still flush with cash. However, firms needing debt financing to achieve a targeted yield on equity investments will find it difficult to source attractive terms, as compared to the first half of 2007.

Lenders will be more diligent, but they are eager for a good deal. With 2008 transactions, there may be one less turn of leverage available – one spin less of earnings before interest, taxes, depreciation and amortization (EBITDA). This means the marginal deal will not be completed, and the financial buyer will be willing to pay less because leverage is reduced.

6. Election Slowdown

History tells us that investors tend to have a “wait and see” attitude for the 90 to 150 days preceding a presidential election, creating a reduction in the number of transactions. Buyers prefer to see how the election unfolds and its potential effect on global markets and the domestic tax environment.

We expect this wait and see period may extend two to six months after the presidential election as well. With the upcoming 2008 election, many business owners will not want to wait until mid-2009, and as a result, may opt to sell in early 2008.

7. IPO Slowdown

In 2008, a dramatic slowdown in initial public offering activity may stimulate middle market M&A activity. Many small- and medium-sized companies see fewer reasons to go public, and the decreased attractiveness in being publicly traded will push more sellers to strategic corporate and private equity buyers.

The Rise of Green Deals

With the buzz surrounding global warming and alternative energy, emphasis on the environment has soared. Middle market companies want to improve their environmental footprint, and in 2008, there will be a rise in green deals to accomplish this objective.

Therefore, venture capitalists have started investing in green startup companies backing experienced management teams with promising intellectual property in alternative fuels, water purification, renewable energy and recycling programs.

8. Clean Technology Opportunities

Clean technology (“clean tech”) improves operational performance, productivity and efficiency while reducing costs, energy consumption, waste and pollution. It encompasses air and water purification, advanced materials, distributed power generation, renewable energy and process control. Acquisitions in these industries are beginning to happen as companies realize that they can be more environmentally sound by purchasing such promising technologies.

According to energy analysts at Clean Edge Inc., annual revenues from wind, solar, fuel cells and biofuels increased 39 percent in 2006 from the previous year, and the clean tech industry is expected to grow more than four times by 2016. In 2007, FOCUS witnessed an increase in green deals, and in 2008, the firm predicts an expansion of clean technology investments.

Exploding Clean Tech Figures*

1,500 clean tech start-up companies operating worldwide in 2007

28,874 scientific journal articles about clean tech published in 2006

Driven by solar and biofuels, energy technology IPO value increased 156 percent in 2006

*The Clean Tech Report, LuxResearch, 2007.

9. Consolidation of Energy and Natural Resource Companies

Middle market M&A transactions in the energy and natural resources industry will increase as companies continue consolidating. Most companies realize they cannot stay competitive without becoming a part of the larger select businesses remaining in their industry. For example, there once were 30 U.S. companies building shafts for U.S. coal mines -- today there are only three. Strong consolidation forces will continue in 2008, increasing the number of businesses interested in merging in the energy and natural resource segment.

10. Increasing Energy Prices

Rising energy costs affect all industries, and the shoe has not completely dropped. Apprehension over these increasing costs remains in the forefront of middle market companies’ concerns. While consumer product companies are more concerned about energy prices than other industries, we still expect a fairly good M&A year in 2008 as these companies continue to find new ways of dealing with increasing energy prices. Meanwhile, we expect businesses providing products and services to the energy sector to thrive.

Douglas E. Rodgers has been CEO and Managing Partner of FOCUS (www.focusbankers.com) since early 2002. He has led the firm’s growth from one office in Washington, DC, to four offices across the US. He has executive level management experience in software, information technology, aerospace, e-commerce, real estate and construction, manufacturing and distribution, serving both commercial and government clients. He serves FOCUS clients across many industries emphasizing merger and acquisitions opportunities.