Market Overview

Recent economic reports have done little to clear up the current economic picture, which is clouded by softness in the general housing market and issues within the sub-prime lending sector. On Wall Street, the Bulls are worried that the Fed’s highly anticipated rate cut may be delayed after the March jobs report came in much stronger than expected, with employers adding 180,000 jobs and unemployment falling to a five year low.  However, signs of weakness also abound with Government reports on new orders for durable goods indicating a slowdown in business spending that could effect economic growth. February orders for durable goods showed a gain of 2.5%, compared to a 9.3% decline in January, but both months were lower than expected. Other February reports also showed indications that business spending on capital goods is on the decline, worrying some economists who had expected business spending to partially offset the economic impact of the slow housing market.

These conflicting views on the economic climate are evident in the differing expectations of the public and top economists. A recent Bloomberg/Los Angeles Times poll found 60% of people surveyed expected a recession, while both Ben Bernanke and the International Monetary Fund’s top economist, Simon Johnson, recently downplayed the potential of a US recession. Despite Bernanke’s assessment that the current six-year economic expansion is not reaching an end, Fed policy makers expect prices to decrease as the economy slows. These price decreases should help alleviate the Fed’s continued  concern about core inflation, which currently stands outside the Fed’s “comfort zone” at an annual rate of 2.4%.

M&A Overview

Through the first quarter of 2007 the deal environment has maintained the fast pace of 2006. According to Dealogic, although overall US deal volume slipped a bit in the first quarter (dropping 11% over deal totals from the fourth quarter of 2006) US merger activity grew 21% from the same period last year. Volume reached $428.7 billion on mega deals, compared with $352.1 billion a year ago, with the number of transactions declining from 2,012 to 1,397. The wave of mega-buyouts has continued unabated, with the Equity Office buyout and the recently announced $28 billion KKR bid for credit card processor First Data. Rumors continue to swirl that a group of investors is targeting Dow Chemical for a $50 billion buy-out deal. 

NYSE Euronext, fresh off its debut as the world’s first trans-Atlantic exchange, is already looking to expand, as the market for stock exchanges continues to be red-hot. The Company is interested in expanding its derivative market in the US and remains open to discussions with exchanges in Europe and Asia concerning future deals. Meanwhile, Nasdaq, following its failed bid for the LSE, is in talks to acquire the Philadelphia Stock Exchange, the country’s third largest options exchange.

This month’s metric compares valuation multiples for public and private middle-market targets across various industry groups in the last twelve months.  The above Exhibit shows that Revenue multiples of private targets were higher than those paid for public companies, especially for business services and software firms (note: a comparison of EBITDA multiples could not be completed due to insufficient data).  One reason for this discrepancy may be the regulatory costs of being public in today’s market.  Regulations related to SarbOx and general SEC scrutiny impacts not only the cost structure of public targets, but also the potential risk of the transaction. Another reason that private targets appear to be getting better valuation is that private companies are typically smaller, with higher growth than their public counterparts. Growing firms have more upside potential, which translates into higher valuations relative to trailing performance. On a relative basis, smaller private companies also stand to gain more from the resources and infrastructure brought to bear by an acquirer, such as established sales channels, better brand recognition and corporate overhead functions. Higher growth rates and better relative synergies enable buyers to pay a higher premium for privately held companies.