The leading finance magazine Financier Worldwide asked Daniel Domberger, Director at Livingstone Partners, to provide the headline article on 2014 trends for its ‘Market Outlook 2014’ report:
Mid-market M&A in 2014
Increased volumes of mid-market M&A in 2014 will be driven by two key trends – increased strategic acquisition by both domestic and international corporates, and increased leverage in private equity-backed transactions. Together, these trends will support strong valuations, particularly for businesses positioned well in ‘hot’ sectors or demonstrating scarcity value. The Media / Tech and Business Services sectors will see the most activity, with the Consumer sector picking up significantly in the second half of the year following a rush of flotations of retailers and similar businesses.
The corporates are coming
The first key trend – and one we are already seeing – is the resurgence of corporate acquirers. Over the past several years, corporates have been extremely selective in the acquisitions they have made, driven by a very rigorous focus on what they have defined as their core strategic priorities. Anything even slightly outside these well-defined strategic parameters has been of little, if any, interest. Depending on how broadly-drawn their strategies have been, this therefore narrowed the scope of their acquisitive interest and reduced the numbers of acquisitions they could contemplate, let alone complete.
Over this period, they have also built up significant cash piles. The enormous cash balances held by US-based giants like Apple capture the headlines and activist shareholder attention, but these war-chests are a common feature of the corporate landscape, including in the mid-market. Over the past 12 months corporates have come under significant pressure to deploy these cash piles to drive growth. With the returns on direct investment opportunities limited, acquisitions are a logical way to achieve these objectives, and corporate acquirers are increasingly spreading their wings in this way.
This applies to both domestic and international acquirers. Over the last year, just over half of UK and German company sales completed with a domestic counterparty; in the US, the proportion is higher because the market is so much larger. This means that just under half of all trade deals in the UK and Germany are completed by a foreign or international acquirer.
The banks are back
The second key trend is increased levels of lending by the major banks to support mid-market private equity-backed transactions. Like the corporates, the private equity houses have had their appetite for transactions restrained over the past few years – not because of pressure to stick closely to a narrowly-defined strategy, but because of the banks’ reluctance to lend in to transactions they perceive as higher risk.
Starting from a low base, the main UK-based lenders have gradually begun to increase the levels of debt they are willing to lend in to private equity transactions. For houses which have adjusted their typical debt/equity ratios and spent the last few years putting more equity into deals than they would ideally have liked, this has two effects.
First, all other things being equal, increased leverage will increase the equity returns – and what private equity house wouldn’t welcome that? Alternatively, that increased level of debt can be used to support a higher entry valuation without jeopardising returns. This allows the equity houses to compete more aggressively on price – which they will have to do to win out over increasingly-aggressive corporates.
Supporting strong valuations
Together, these two trends – pressure on corporates to spend, and increased availability of debt for private equity houses – will support strong valuation levels throughout 2014 and beyond.
Demand – and hence valuations – is already and will remain particularly strong in hot sectors in the mid-market such as Ad-Tech and Fin-Tech, driven by high-profile transactions and perceptions of massive growth potential.
Companies which can demonstrate real differentiation, in position, product, global coverage or scale, will continue to benefit from the scarcity value which has supported valuations over the past few years – with a very limited number of high-quality and attractive businesses available to acquire, those corporates and investors which have wanted to complete a deal have had to compete very hard to do so, driving valuations up towards pre-downturn levels. This trend will continue, and companies which are perceived to be leaders in their field will benefit significantly from this.
Some sectors are more equal than others
Those sectors which will benefit most from these trends in 2014 are those which are more pro-cyclical, and which will therefore follow quickly on the macro upturn. For example, the Media / Tech sector has been particularly active over the past year as the early signs of recovery have emerged. This increase in transaction volumes has been led by the Tech sub sector, followed closely by Media (both old and new). Marketing Services, historically an early beneficiary of a rebound, has been slower to benefit but is now seeing the pace quicken materially, led by the Tech and Digital segments.
In the public markets, there is a lot of interest in the Consumer sector, another pro-cyclical part of the market, and one which is expected to grow rapidly from this point onwards. This confidence in the consumer will feed through to higher mid-market transaction volumes in the sector in the second half of 2014, after a series of high-profile flotations scheduled for later this year.
Business Services has remained reasonably robust through the downturn, and looks set to retain its importance in mid-market M&A, while the Industrials sector will demonstrate further increases in activity in the second half of 2014.
Overall, during the course of the year the mid-market will show a sustained increase in M&A activity levels across all sectors, driven by domestic and international strategics, and private equity houses drawing on the (gradually) increasing levels of support from the banks.
To view the report, download the PDF below.