Market Overview

Fresh off of a five day rally, the market has been treading water in anticipation of Ben Bernanke’s speaking engagement at the Economic Club of New York Monday night.  Although Bernanke is not expected to reveal much ahead of next week’s Federal Reserve policy meeting, his comments regarding the yield curve and monetary policy will be eagerly anticipated.  Recent Wall Street buying activity and bond price increases have been spurred by investors questioning whether interest rates have much further to climb.  Slowing economic growth and little evidence of inflation, as seen in tame consumer price pressures, a soft housing market, and easing manufacturing activity, have the market questioning interest rate increases that once seemed a given.  Ahead of the Fed’s policy meeting next week, both the Dow Jones Industrials and S&P 500 have reached highs at levels not seen since May 2001.

However, questions remain about the state of the economy.  Warren Buffett recently reiterated his prediction that the US dollar will face pressure as a result of the record US trade deficit.  The US current account deficit stands at a record in both dollar terms  ($804.9 billion), and as a percentage of total US economic (6.7%). This represents a 20.4% increase from the previous record of $668.1 billion set in 2004.  Coupled with his warnings on the US dollar, Buffett also cautioned stock investors to expect to earn less than historical returns, due in part to increased costs of trading, advice, and money management.

M&A Highlights

As the market has continued its hot M&A pace, telecom seems to be one of the latest activity drivers.  AT&T has continued its acquisition trend, grabbing recent headlines for its $67 billion offer for BellSouth.  This deal allows AT&T to acquire full control of joint venture Cingular, as well as combines the companies’ complementary efforts to enter into the cable market.  In addition, Softbank scored a huge jump start on its efforts to break into the Japanese mobile phone market with its acquisition of Vodafone’s Japanese unit, J-Phone, for $15 billion. This deal allows Softbank to enter the mobile market with over 15 million subscribers and a mobile network, rather than starting from scratch. Vodafone’s sale of its Japanese unit has also fueled speculation that the company will be entertaining offers for its stake in Verizon Wireless, as it refocuses its efforts on its core European business.

The above exhibit illustrates median revenue growth and EBITDA margin over the last twelve months for our sample of publicly traded middle-market companies. Business service companies experienced the strongest growth, with several staffing and consulting companies such as Brain Consulting, TeamStaff and Edgewater leading the charge. The software segment also experienced healthy growth rates, with top performers in e-commerce (iMERGENT, Perficient) and supply chain management (Click Commerce, Logility) sectors. Growth for industrial products was more moderate, with strong performances expansion for natural resources companies (Vulcan International, Natural Gas Services Group) and related segments such energy technologies (Quantum Fuel Systems Technologies, Fuel Tech N.V.).

Median profitability as measured by EBITDA margins was very similar for Business Services and Software companies, while Industrial Products lagged a little. Note that Industrial Products companies are typically more asset intensive, so that the gap with the other two segments is therefore more substantial form an actual cash flow generation perspective.