In this edition of our market update, we broaden the scope of our typical analysis to include the M&A market as a whole. The result is a conclusion that will sound familiar to our previous article, total deal value and company valuations are down on a reduced number of transactions in the first half of 2020, in large part driven by constrained capital markets and a dislocation between buyer and seller valuation expectations.
M&A transactions are down, both in terms of volume and total value
We looked at all M&A transactions for private and public deals since January 1st, 2018 through June 30th, 2020. This is more than 26,400 trades. Of that, roughly 98% were either less than $1B in value or didn’t disclose a deal value – the “middle market” where Livingstone spends 100% of its time. Despite headline trades like Aon or Grubhub, deals worth more than $5B are down 53% year-over-year (“YoY”), including notable stalled deals like Taubman and Victoria’s Secret.
The middle market, on the other hand, seems to be faring better, with volumes down only 28% YoY through the first half of 2020 (11% YoY in Q1 and 46% YoY in Q2). A meaningful decline, but it also indicates thousands of deals are getting done and markets are open, though constrained.
Many strategic buyers (operating companies in a similar industry as their target) remain hesitant to pursue acquisitions given the uncertainty in their own businesses, especially for companies with exposure to the hardest hit end markets. These buyers are prudently protecting their balance sheets as the second half of 2020 looms with rising infection rates in the U.S. and an impending election. Deal flow traditionally slows when the future is uncertain, and we have plenty of uncertainty these days.
Dislocation between buyer and seller value expectations are driving volumes and valuations lower
While strategic buyers may be wary of pursuing acquisitions, unless they are strategically opportunistic and the valuation is compelling, financial buyers (private equity groups, for example) remain eager to see acquisition opportunities. We continue to hear from the financial buyer community that they are open for business, have plenty of capital with which to do deals, and can be creative with respect to valuation and structure to get deals done in this unparalleled environment.
The trouble in their arithmetic is that financial buyers often rely on debt capital to financially engineer returns. Lenders, inherently more risk-averse than equity investors, have been reticent to deploy the same levels of financial leverage that they were even six months ago. The cost of that debt is also becoming more expensive. The result is that financial buyers cannot achieve the same target ROI at precedent acquisition multiples. Their options are to reduce the acquisition price, tie more of the consideration to the post-acquisition performance of the business in the form of an earnout, or another mechanism that makes the actual acquisition cost more variable.
All this means that sellers must accept a discount on their consideration or assume the risk of future performance under a shared ownership scheme. Sellers, particularly for businesses that are surviving or even thriving, are unwilling to make these concessions.
Where the opportunities lie amid the chaos
There is an argument that exceptional businesses should use this opportunity to go to market, take advantage of the dearth of sellers and the competition between the buyers, to drive outlier valuations. The main risk associated with this strategy is that if the buyers don’t deliver the valuation the seller expects, the seller is then forced to postpone the transaction. This can mean more distraction and fatigue on the part of the selling company, and confusion in the market to the extent that the seller now has to justify a higher valuation 6-12 months later given the fundamental business likely hasn’t changed that much. However, there are a few steps businesses can take to mitigate this risk and increase the likelihood of a successful capital raise or M&A process.
First, make sure your house is in order and use this time to set yourself up for success. We will be sharing a more detailed article on this topic in the weeks to come but the main element is this: start looking hard at the underlying data and key performance indicators that are relevant to your specific business, and start capturing current data as well as compiling the historical metrics for context.
A sell-side or recapitalization process is always a highly diligenced transactions but, now more than ever, having good historical data to demonstrate a business’s operational performance will help facilitate a successful process, as well as substantiate projected financial estimates.
Second, use your time and energy efficiently with a targeted process. Some transactions are marketed very widely in an effort to maximize value. This can create a tremendous amount of extra work on the part of the selling management team, wasting time and energy. This is where the right investment bank, one with industry knowledge and access to the right buyers, can help sellers identify buyers willing to compete over your businesses.
Ultimately, for businesses contemplating a sale, a recapitalization, or an acquisition in the next 24 months, it is a good time to start a conversation with a financial advisor that knows the market for your business. A seasoned investment bank, like Livingstone, with deep industry knowledge can help evaluate a company’s market-readiness, outline pre-transaction strategic initiatives to prepare for a marketing process, and then run a disciplined process that will create competition among buyers. A little preparation now will pay huge dividends later, no matter what the markets may bring.
Livingstone is an international mid-market M&A and debt advisory firm with offices in Beijing, Chicago, Düsseldorf, London, Los Angeles, Madrid, and Stockholm. We have deep industry expertise, and extensive global coverage, with dedicated teams across our offices serving the Business & Technology Services, Healthcare, and Industrial segments and close an average of 50+ transactions annually.