M&A 2006 Recap and 2007 Preview

In January 2005, I wrote an M&A 2004 Recap and 2005 Preview, that described the M&A environment and my thoughts regarding how the coming year would unfold.  I thought it would be an interesting time to try it again.  Remarkably, two years later most of the critical trends that I identified are still in place, and in many cases, are even more positive than in 2005.

US M&A activity has grown rapidly during the past five years, from approximately 6,400 transactions in 2002 to over 10,300 transactions in 2006.  We are on the verge of passing the 2000 high-water mark of 10,400 transactions.  It is certainly a good time to sell a company.  In the annual ACG/Thomson Dealmakers Survey (a year-end survey of over 1,200 dealmakers), 93% of those surveyed characterized the M&A environment as ‘good’ or ‘excellent’, as compared to 72% in 2005.  When asked “Is it now a buyer's or seller's market?”, 75% of respondents deemed it a seller’s market with only 10% viewing today’s M&A market as a buyer’s market.  Valuations have risen accordingly.  In the same survey, 61% of dealmakers expect average EBITDA multiples to range between 7 and 10 times EBITDA over the next six months, while only 28% expect EBITDA multiples in the 5 to 6 times range.

Let’s look at the positive trends for M&A that I laid out in 2005 and see where they stand today:

• Stable economy and financial markets.  A strong economy and strong financial markets are still in place with “no end” in sight.  I think the real question is  "When Will the M&A Party End?".  M&A is highly cyclical and sensitive to the health of the economy and financial markets.  We are confident in the market for M&A for the next 12-18 months but we believe that we are closer to the end of the cycle than the beginning. 
• Growth in the middle market.  We meet with a large number of companies every year and middle market businesses are humming along right now.  We are seeing consistent “record” years for middle market businesses in terms of both profitability and revenue.
• Deals beget deals.  M&A volume has a tendency to build on itself.  As business owners see others exiting at attractive valuations, they jump into the fray.  With hungry private equity and strategic buyers still at the table, there is ample demand for new supply coming into the market.
• Cooperative lending environment.  Interest rates have been stable and attractive.  We are seeing very attractive lending rates and lending multiples.  If you believe that a leveraged buy-out is the right exit for you, it may be the right time to explore this option.
• The valuation gap is closing.  For the past two years, the valuation gap between buyers and sellers has been largely closed.  In other words, deals are happening because there is alignment between bid/ask prices.  Today, the question is “Will buyers remain confident in the economy and the future earnings potential for businesses?”.  This expectation is a key element for the substantial multiples being paid in today’s market.  If buyer confidence falters, inflated valuation expectations could lead to failed deals and force M&A volumes down.  In other words, another valuation gap could emerge.
• Pent-up demand from buyers and sellers.  This has worked itself through the system since 2004.  Strategic buyers have been active for some time now.  I think that there is a growing risk that some portion of strategic buyers will be suffering from deal indigestion in the near future.  Private equity however is still very active and we see no end in sight at this point. 
• Leveraged buy-out activity is up.  Funds continue to raise record capital and they need to put this capital to work.  Consequently, private equity groups still flush with capital, supported by healthy debt markets, are paying competitive prices to get deals done.

                                                                               - Elliot Williams

                                                                                 President, Mirus Capital Advisors

Sources: CapitalIQ and Mirus analysis. Copyright 2006, Mirus Capital Advisors, Inc.  All rights reserved. Mirus Capital Advisors does not assume any liability for errors or omissions.