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By James S. Cassel
January 19, 2014
When it comes to middle-market mergers and acquisitions, 2014 is positioned to be quite a happy new year — the best one yet since 2008. For middle-market business owners seeking to sell their businesses, borrow money or raise capital, it looks like the stars may align to present attractive opportunities.
Typically, the M&A market gets bifurcated into large deals and small deals. In 2013, the large deal business came back but the middle market lagged. In 2014, we will see the large deal business continue while more small deals and middle-market deals begin to happen.
M&A last became bullish in 2006, and the market has since been hungry for another peak. Q4 2012 was particularly strong, and some middle-market analysts projected that 2013 would post record-breaking valuations for businesses, creating an ideal climate for exits and driving bidding wars. However, preliminary data show that the middle market lagged a bit in 2013, as the overall dollar value of deals closed in 2013 was only slightly higher than the dollar value of deals closed in 2012. According to a January 2014 S&P Capital IQ report, the dollar value of deals surged by 20.1 percent across the board between 2012 and 2013, predominantly driven by a few megadeals, but the number of deals actually slipped by 3.9 percent.
The end of 2012 was particularly strong due to the tax law changes. The slower deal volume can be attributed in 2008-2012 to a wide array of factors, including posturing in Washington over tax and estate issues, the slow debt market recovery, lack of job growth, and the stalled economy. Granted, this slow upward trend has been building since 2008, and early projections for 2014 indicate that this gradual increase will continue throughout the year. There could be pent up demand to sell.
In my experience at Cassel Salpeter, an investment banking firm that focuses on the middle market, several industries — namely healthcare, media, telecom and technology, financial services, insurance and real estate, retail, energy and manufacturing — enjoyed more concentrated deal-making opportunities. Companies with predictable cash flow were able to leverage multiples of four and five times cash flow, and companies with EBITDA in excess of $25 million gleaned even more. Calling 2013 a bad year or a good year all depends on where you happen to be standing, but across the board, it was a year of learning, and those lessons shed a telling light on what the market can expect from 2014.
In a recent KPMG survey of more than 1,000 M&A professionals, approximately 63 percent responded that their U.S. companies or clients will initiate at least one acquisition this year, and 36 percent expect their companies or clients will complete a divestiture. In a similar survey among 145 C-level executives, almost three quarters indicate that they expect their companies to make an acquisition in 2014 — almost double from last year. Are they righteously optimistic or kidding themselves?
The key drivers of this uptick in M&A confidence include: employment is improving; GDP has increased and is expected to be north of three percent in 2014; customer confidence has improved; home values are improving; the stock market is up; and interest rates remain relatively favorable. Despite the doom and gloom forecast that has been permeating some media, which is now finally subsiding, there is still a powerful notion of stability and safety in North America’s M&A markets. So, while regions like Western Europe and China might have some opportunities, the U.S. will undoubtedly attract dollars from investors seeking stability and growth.
Although 2014 might produce some megadeals, the middle market will be the main driver of M&A. According to the KPMG survey, approximately 77 percent of survey respondents say they expect their M&A deals to be valued under $250 million. This is an important detail: Middle-market executives have expressed confidence regarding their ability to access credit markets to finance deals, and simultaneously, a wide swath of companies are sitting on large reserves of cash, so these middle-market deals will become attractive targets for larger companies in the coming 12 months. The savvy ones have spent the past few years paying down lines of credit to prepare for the next bullish era of opportunities.
On the subject of credit, interest rates will remain low for at least the first six months of the year, maybe longer. Simply put, it’s ideal to borrow now, because if and when the Federal Reserve reduces its stimulation, interest rates may begin to move. A small uptick will produce minimal impact, but more significant increases could shake things up.
That doesn’t mean there isn’t money out there, particularly in the private equity markets and strategic buyers. Private equity firms are flush with cash and credit availability as are companies. Companies are looking to buy, and the convalescence of factors like cash reserves and increased consumer confidence will produce a favorable environment in 2014 for companies looking to make acquisitions. In addition, we can also expect that this will be a good year for initial public offerings, particularly for technology, financial services and health care ventures.
The unknown is not whether there are buyers but whether there are sellers willing to sell. At some point, aging business owners will make the difficult decision and take the plunge. As with all things, time will tell how the New Year will treat the middle market’s M&A sector, but insights from last year and new developments in the market are promising a healthy and strong 2014.
James Cassel is co-founder and chairman of Cassel Salpeter & Co., LLC, an investment-banking firm with headquarters in Miami that works with middle-market companies. www.casselsalpeter.com