M&A AND CAPITAL MARKETS OUTLOOK SPRING 2015

Transcription

1 M&A AND CAPITAL MARKETS OUTLOOK SPRING 2015 Inside this Issue: M&A Market Overview M&A Market Activity Middle Market Deal Valuations Private Equity vs Strategic Valuations Middle Market Leveraged Buy Out Capitalizations Overall M&A Market Commentary M&A market activity for larger companies continued to show improvement during 1Q15, building on last year s momentum. 1Q15 deal activity includes 15 newly announced M&A deals with a transaction size of $10 billion+, causing a record quarter for large deal activity and putting 2015 on path to achieve a record annual M&A dollar volume. Included in these deals are a few marquee transactions: FedEx s acquisition of TNT Express, H.J. Heinz merger with Kraft Foods and drug maker Mylan NV s bid for Perrigo. These large transactions reflect a high level of management optimism in both the global economy and their underlying businesses. This robust M&A activity was encouraged by low interest rates, abundant debt financing and a strong stock market. On the other hand, middle market M&A activity, defined as deals with values below $300 million, did not show the same level of market enthusiasm. The unanticipated year end slow down in deal volume at the end of 2014 continued into 1Q15. On a year over year basis, 1Q15 middle market dollar value and deal volume activity was down 7% and 16%, respectively, from the activity levels recorded in 1Q14. While the first quarter is typically the slowest quarter of the year in terms of M&A activity, 1Q15 activity was somewhat slower than normal. We continue to see an increase level of middle market participants exploring their strategic options but this interest has not yet translated into commitment by sellers and true deal activity. Concerns on the direction of the U.S. economy may have contributed to the lack of seller commitment. The dramatic fall in energy prices, general weakness in foreign markets and a strengthening dollar have all had both positive and negative effects on companies and the U.S. economy. Throw in the cold snowy winter in the Northeast and you have a perfect storm (literally in Boston) for a weak 1Q15 economy. Add another surprising monthly employment report showing a sharp deceleration in March hiring and couple that with unexpected softness in consumer spending, capital investment and manufacturing output and you start to see increased concern for a broad slowdown in the U.S. economy. While throughout 2014, the U.S. economy has Financial Markets Outlook Total U.S. Middle Market Loan Issuance Interest Rate Environment Middle Market Debt Multiples Transaction Highlights Prairie acts as exclusive financial advisor to Van Meter Inc. shown improving growth in quarterly GDP, many economists are now downgrading their growth forecasts of 1Q15 GDP and full year 2015 GDP. The strategic and financial buyers still have abundant capital to make acquisitions. The banks and other lenders are still anxious to make new loans to fuel corporate growth and acquisitions. Low interest rates make the costs of additional debt capital very low. All of these factors should contribute to a stronger middle market M&A environment. The current market represents a significant opportunity for sellers. We are optimistic that M&A activity will increase later this year as more middle market sellers recognize the sellers market. This is a good time for business owners to look at their financial options and consider a liquidity event Prairie Capital Markets, LLC. All Rights Reserved

2 M&A Market Activity Middle market M&A activity has tapered during 1Q15 continuing a trend we first noted in the last quarter of Typically the first quarter of each year shows a decline in deal activity after the rush of fourth quarter closings in the previous year. This time the 4Q14 activity was also soft and started a declining activity trend that continued through 1Q15. High company valuations, abundant lending sources, aggressive PE funds and well capitalized strategic buyers would all seem to suggest that we should see a more robust deal market and an increase rather than decrease in activity. Since 2012, we have been in a sustained strong sellers market which may have exhausted the supply of new saleable companies for the M&A market. The $57 billion volume of middle market deals in 1Q15 reflected a year over year decrease of about 7% from the $61 billion volume of deals recorded in 1Q14 and a 23% decrease from the dollar volume recorded in 4Q14. Similarly, the number of middle market deals recorded in 1Q15 was down about 16% and 20%, respectively, when compared to the number of deals closed in 1Q14 and 4Q14. The average middle market deal size of $36 million was up slightly from the $32 million deal size average in 1Q14. As we discussed in previous quarters this has been a lengthy seller s market and the readily saleable businesses owned by both private equity funds and individual owners have already been harvested leading to more constrained activity. The 1Q15 slowdown in Private Equity exit activity seems to support this theory as well. Middle Market Deal Valuations Middle market deal valuations remained high in 1Q15, remaining consistent with what we have witnessed in 2013 and The deal demand/supply imbalance coupled with aggressive lenders, PEs with abundant investable capital and greater strategic buyer activity are all helping sustain these high valuation levels. At these high valuation levels buyers expect a near perfect asset. As a result, the intensity of the buyer due diligence has increased leading to a lengthened and a more risky deal closing process. Sub $25 million deal valuation multiples tend to stay in a narrow range centered around 5.5x reflecting the perceived increased risk of these lower middle market companies and the resulting ceiling on valuation multiples. Valuations on the large end of the middle market continued to trend higher as PE Funds and strategic acquirers increased their participation in the $50 to $100 million valuation segment. This increased competition for larger deals has resulted in higher valuations for upper middle market companies. This presents a multiple expansion arbitrage opportunity where a buyer employs a platform build up strategy by acquiring a number of smaller companies at low multiples, combining them into a larger entity and then selling the resulting larger enterprise at a higher multiple. As cited in previous quarters, cheap, abundant credit, record levels of PE fund raising and a relatively cash rich and unleveraged strategic buyer community are all contributing to a maintenance of the higher valuation levels. As we have suggested in our previous reports, properly prepared, solid performing companies that are well positioned in the M&A market will continue to receive strong buyer interest and premium valuations. 2 Prairie Capital Markets, LLC Quarterly Middle Market Perspec ve

3 Private Equity versus Strategic Valuations Strategic acquirers continued their aggressive participation in the M&A market, increasing their acquisition multiples to an average of 8.0x. The economic slowdown in some sectors, the stronger U.S. dollar and weakness in demand from Asia and Europe have all caused large international strategic companies to look for growth through other venues including acquisitions. These strategic buyers are using the current deal environment to pick up synergistic companies and assets at what they consider reasonable valuations. In addition, the relatively cheap financing market is providing strategic buyers with the ability to finance acquisitions almost entirely with debt further enabling them to stretch on valuations. During 1Q15 strategic buyers continued to aggressively bid on acquisitions. According to our data, strategic buyers acquired businesses at a median 8.0x multiple of EBITDA in 1Q15, a valuation level almost 25% higher than the PEs. The relatively slow increase in Financial Buyer acquisition multiples reflects PE Funds market discipline and tendency to avoid bidding up valuations. Companies with good operating performance and growth prospects continue to be ideal for new PE platforms. Platform acquisition represents an area where PE buyer discipline is occasionally broken and PE Funds will make an acquisition at strategic like valuations. A continuing overhang of investable funds and a limited investment horizon provide PEs no alternative but to continue to participate in the M&A market. The slowdown in deal volume over the last 6 months has resulted in a greater supply demand imbalance and a continuation of the sellers market. The interest in M&A deals by both strategic buyers and PE funds provides well prepared, attractive sellers with an opportunity to continue to take advantage of the M&A market s strong valuations. The data reflects valuation multiples for all size deals. Prairie Capital Advisors estimates that for middle market deals below $50 million, valuations are generally 1.0 to 2.0 multiples lower than the levels reflected below. Middle Market Leveraged Buy Out Capitalizations While nowhere near the aggressive capital structures of the previous decades, the use of larger amounts of debt is putting leverage back in the Leveraged Buyout ( LBO ) market. While commercial banks and other regulated lenders are forced to be more conservative in their lending structures they remain anxious to make new loans and participate to the extent they can in new deal opportunities. The business development companies ( BDCs ) and other unregulated lenders are innovating in both credit products and structures and leading to a dramatic increase in the availability of debt capital. The mezzanine funds are also active and looking for new investment opportunities. In this current market, capital available has not been a limiting factor for deal activity. Larger amounts of debt and higher leverage levels are becoming more acceptable in LBOs. This has resulted in the Equity contribution in a typical LBO being about 45% of the capital structure in early 2015 down from almost 52% in Innovations in credit products, growth in the number of unregulated lenders, the increased sophistication of borrowers have all lead to an unprecedented availability of capital for LBOs even with increased regulatory scrutiny of bank lenders. Mezzanine funds continue to aggressively pursue deals and are more relevant in larger LBOs and smaller recapitalizations and growth financings. While interest only and payment in kind ( PIK ) structures dominate the markets, the mezzanine funds also like equity co investment opportunities to improve their returns and increase their investment amount in deals. The currently attractive capital market environment and abundant amounts of debt enables both strategic and PE buyers to stretch their bids for companies and sustain the currently high valuation levels. 3 Prairie Capital Markets, LLC Quarterly Middle Market Perspec ve

4 Overall Comment on the Financing Markets Lenders of all types, including commercial banks, asset based lenders, BDCs, second lien funds and mezzanine investors contribute to make cheap and abundant credit available to the deal market. All sectors of the financing markets are aggressively pursuing deals. The lack of strong growth in middle market M&A activity is leading to slower loan growth and increasingly aggressive lender behavior and more competition for the limited deal activity. The increased competition has led to more favorable lending terms, including fewer and less restrictive covenants, increased amounts of leverage and lower credit pricing. However these improvements in terms and pricing seem to have stabilized at the current levels. All these factors are contributing to support the market s high valuation levels and should support increased M&A deal activity. Debt is playing a greater role in the deal market and that is expected to continue throughout The economic weakness noted in 1Q15 raises the question of when the Federal Reserve ( Fed ) will begin to increase interest rates, thus ending its Quantitative Easing and returning to a more normal Fed policy. The economist consensus seems to be that the weak March employment report and other indications of economic softness may delay the beginning of the Fed rate increases from June to September Interest rates have remained relatively unchanged throughout The collapse of oil prices and softening global economies caused longer term rates to decline in 1Q15 as global investors sought the relative safety of U.S. Treasuries. As of the end of 1Q15, the long end of the U.S. Treasury yield curve was down 26 basis points leading to excellent opportunities to lock in low borrowing rates on long term loans. This is a borrowers market for those companies with the need for long term debt capital. Total U.S. Middle Market Loan Issuance Muted demand for middle market loans continues to plague lenders in 1Q15. Loan issuance during 1Q15 was about 20% lower than the issuance in 1Q14. If this trend continues, loan volume could end 2015 at the lowest level in more than three years. A more robust middle market M&A environment is necessary to jump start the bank lending market. The seemly endless low interest rate environment has reduced the urgency for companies to take advantage of the current market and lock in low interest rates for new borrowings. Furthermore the very slow economic activity levels have reduced the need for companies to make capital investments to grow their business. The senior debt markets are bifurcated with the regulated lenders, like banks, focused on corporate borrowers lines of credit and operating business needs like payroll and checking accounts. Due to increased regulatory scrutiny, banks continue to be selective in making new loans and are more focused on non leveraged transactions. Non bank, unregulated lenders on the other hand, are loosening covenants and lending terms and contributing to higher amounts of senior leverage in capital structures. Interest Rate Environment Interest rates on the low end of the yield curve have shown little change over the last several years reflecting a slowly recovering U.S. economy and very low inflationary pressure. The long end of the yield curve has moved even lower during 1Q15 reflecting the flight to quality as world investors invest in relatively safe US Treasuries. One and three month LIBOR has remained at very low levels for the last several years reflecting the effects of the Federal Reserve Quantitative Easing programs. The March 2015 jobs report reflected continued concern over jobcreationandthestrengthoftheoveralleconomy.thelack of wage growth and the low labor participation rates still trouble many economists. Low LIBOR base rates and stable to narrowing lending spreads make this an attractive market for borrowers. 4 Prairie Capital Markets, LLC Quarterly Middle Market Perspec ve

5 Financing Pricing Middle Market Debt Multiples Debt leverage levels are increasing as non banks and other unregulated lenders begin to play a greater role in middle market lending. In certain middle market leveraged loan situations, these unregulated lenders are allowing leverage of 4.0x and even 5.0x multiples of cash flow. The bank lenders continue to maintain their credit discipline largely to satisfy their regulators. The regulators limit the amount of Highly Leveraged Transactions ( HLT ) exposure that a bank can hold. Bank provided senior credit facilities remain well inside of the relatively conservative 3.0x EBITDA senior debt ratio to avoid the HLT basket and the ire of the regulators. Total leverage for middle market companies on average is below the 4.0x leverage multiples observed in the mid 2000s. More aggressive mezzanine debt providers are contributing more of the average capital structure and helping increase the overall leverage. These conservative leverage ratios are setting an upper limit on Middle Market M&A valuations for disciplined PE buyers. Bank Financing Upfront Fees LIBOR Spread Asset Based Loans bps bps Cash Flow Loans EBITDA less than $10M Unleveraged Loans 0 50 bps bps Leveraged Loans bps bps Cash Flow Loans EBITDA more than $10M: Unleveraged Loans 0 50 bps bps Leveraged Loans bps bps Mezzanine Debt <$10M EBITDA > $10M EBITDA Upfront Fees 2.00% 2.00% Current Pay Coupon 11.00% 13.00% 11.00% 13.00% Payment in Kind (PIK) Interest 0.00% 3.00% 0.00% 2.00% All in IRRs 16.00% 19.00% 13.00% 16.00% Source: Pricing is based on guidance provided by a number of commercial and mezzanine lenders Note: Warrants and other yield enhancements comprise the incremental return required to meet the all in internal rate of return ( IRR ). Prairie Capital Advisors, Inc. is an employee owned company offering investment banking, ESOP advisory and valuation services to support the growth and ownership transition strategiesof middle market companies. Since 1996, we have led hundreds of sale, merger, acquisition, ESOPand financing transactions forour clients. All securities transactions are effected and offered through Prairie Capital Markets, LLC ( Prairie ), member FINRA/SIPC. This document is a result of Prairie Capital Market, LLC and is for informational purposes only. It is not intended as an offer or solicitation with respect to thesaleorpurchaseofasecurity.theopinionsexpressed are the views of the writer and do not reflect the views and opinions of Prairie. Prairie shall not be liable for damages resulting from the use of or reliance upon the information presented herein. 5 Prairie Capital Markets, LLC Quarterly Middle Market Perspec ve

6 TRANSACTION HIGHLIGHT About Van Meter Inc. Van Meter Inc. is a wholesale distributor of automation, electrical, datacomm, lighting and power transmission products and services. Since 1928, Van Meter has provided unparalleled customer service, superior products and customized solutions and services to their customers. Prairie Capital Advisors acted as the exclusive financial advisor to Van Meter Inc. for the acquisition of Miller Electric Supply Inc. The acquisition of Miller Electric expands Van Meter s presence in Iowa to 14 locations. Van Meter continues to seek acquisition opportunities within the electrical wholesale distribution industry as well as complimentary distribution industries. PRAIRIE CAPITAL ADVISORS RANKS IN THE TOP 10 U.S. FAIRNESSOPINION ADVISORS Prairie Capital Advisors, Inc., a leading corporate advisory and investment banking firm, has been ranked the number eight fairness opinion advisor in the United States in Thomson Reuters Mergers & Acquisitions Financial Advisors Review for the first quarter of The league table is published by Thomson Reuters on a quarterly basis. CONTACTS Terrel Bressler Managing Director tbressler@prairiecap.com Robert Auer Managing Director rauer@prairiecap.com Timothy Witt Managing Director tim.witt@prairiecap.com Anthony Dolan Vice President adolan@prairiecap.com Oakbrook Terrace One Mid America Plaza Suite 1000 Oakbrook Terrace, IL Atlanta 3715 Northside Pkwy Building 200, Suite 675 Atlanta, GA Cedar Rapids nd Street SE Suite 1225 Cedar Rapids, IA Chicago 125 S. Wacker Drive Suite 300 Chicago, IL Philadelphia 100 N. 18 th Street Suite 300 Philadelphia, PA Prairie Capital Markets, LLC Quarterly Middle Market Perspec ve