Business Products and Services: McGladrey Quarterly Private Equity Deal

Transcription

1 Business Products and Services: McGladrey Quarterly Private Equity Deal Insight Analysis Experience the power of being understood. SM Q3 213 Powered by

2 McGladrey announces the Q3 213 Private Equity Deal Flow Profile Private equity (PE) dealmaking in the business products and services (B2B) industry continued to decelerate in Q2 213, with PE firms completing just 95 deals totaling $8. billion. These are some of the lowest quarterly totals seen in the last decade, but the slowdown in investment has not necessarily been due to poor performance from companies in the industry. The clients I deal with seem to be performing better than they were this time last year and are continuing to improve, says Mark Gaines, partner in the business products and services practice at McGladrey. One of the main drivers behind the slow start to 213 was the high level of investment seen in Q4 212, in the anticipation of higher tax rates and the changing regulatory landscape. The 246 transactions and $34.4 billion of capital invested in Q4 were the highest totals in the post-crisis era, which depleted much of the pipeline for deals that would normally have closed in the first half of 213. The PE marketplace in Q2 was similar to the previous quarter, but we re starting to see a change, says Milton Marcotte, practice leader of transaction advisory services at McGladrey. The first six months of this year have been light because of the pull forward in the second half of 212, but we re starting to see the normal pipeline of activity return and there is a lot of M&A activity with new companies in play. Another key factor in the depressed level of deal activity has been the relatively high level of valuations and purchase price multiples. Many quality companies were acquired in second half of 212, which has inflated the price for the few attractive opportunities that are currently available. To that end, sales processes have been increasingly competitive and frequently involve multiple bidders. Exits have also been sluggish through the first half of the year, with only 54 transactions being completed. IPOs have been a bright spot, though, with eight PE-backed B2B companies going public in H As is the case on the dealmaking side, the pace of exits is expected to quicken in the coming quarters. Focusing on the middle market, McGladrey provides PE firms and their portfolio companies with integrated transaction advisory, tax, assurance and consulting services. Our work with 4, business and professional services companies and 1,1 PE firms gives us a deep understanding of the key trends impacting deal flow in the B2B industry. In the past five years, we have performed due diligence on more than 1,4 deals, nearly 2 of which were B2B transactions. Check out our top 12 list of accounting due diligence observations for the B2B industry on page 6. Donald A. Lipari National Executive Director, Private Equity Services don.lipari@mcgladrey.com Mark Gaines Partner, Business Products and Services Practice mark.gaines@mcgladrey.com Milton Marcotte Practice Leader, Transaction Advisory Services milton.marcotte@mcgladrey.com Benjamin Redman Director, Transaction Advisory Services benjamin.redman@mcgladrey.com Michael Fanelli Director, Transaction Advisory Services michael.fanelli@mcgladrey.com [1]

3 B2B private equity deal flow B2B private equity deal flow by quarter $8 $7 $6 $5 $4 $3 $2 $1 $ $5 $59 $71 $45 $21 $19 $22 $9 $7 $6 $6 $8 $17 $22 $22 $32 $2 $18 $28 $26 $16 $17 $17 $34 $11 $8 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q Capital invested ($B) # of deals closed Coming off one of the most robust quarters for dealmaking since the financial crisis, most PE industry professionals anticipated a slowdown in the first half of 213. But the anemic level of dealmaking in the first half of 213 would have been difficult to predict even for the most pessimistic of observers. The $8. billion invested in Q2 213 is the lowest quarterly total since Q4 29, and the 95 completed deals were the fewest in the last decade. It seems like overall business activity has flat-lined in the first half of 213, but most management teams are optimistic about activity in the second half of the year, says Mike Fanelli, director of transaction advisory services at McGladrey. The slowdown in dealmaking is not for a lack of trying; in fact, one of the impediments to deal flow in the B2B industry over the last two quarters has been the high number of bidders commonly involved in the sales process. This has resulted in a dichotomy between the level of internal activity at PE firms and the amount of capital currently being invested. Multiples seem to be high; it s very competitive on the buyer B2B private equity deal flow by year $25 $2 $15 $1 $5 $ , $63 $7 $132 $225 $71 $26 $92 $91 $ $ Capital invested ($B) front, Marcotte observes. The sales processes are being driven in a very competitive way because everyone knows that it s a seller s market. You have buyers investing a lot of time and money on deals where they re not even in exclusive bidding relationships due to the lack of deal flow. A significant trend that has emerged for the deals that are going through # of deals 1,4 1,2 1, in 213 is a shrinking proportion of platform buyouts, with more firms pursuing add-ons deals and minority investments. [The low number of platform buyouts] may be due to the flurry of activity during the second half of 212, Fanelli says. PE firms are now focusing on increasing geographic presence, revenue and EBITDA for those acquisitions made in 212 via add-on acquisitions. *As of 6/3/213 [2]

4 Deal flow details Deal activity in Q2 213 by sector PE transactions (count) by sector 1% Commercial services 56% 8% 6% Other Transportation 5% 4% Transportation Commercial products Commercial products 38% Other 1% 2% % * *As of 6/3/213 There are some small shifts when examining B2B dealmaking by sector from year to year, but the overall makeup has remained quite consistent. saw its share of B2B deal flow dip below 5 percent in 211 and 212, but the sector rebounded back to 53 percent of B2B deals through the first half of 213. The media and information services sector led the way for B2B investment through the first half of 213. A couple notable transactions in this space include Onex Partners $95 million buyout of Emerald Expositions and AEA Investors $68 million minority investment in Brand Networks. In commercial products, much of the slowdown in 213 has resulted from a steep decline in deals in industrial supplies and parts, which has been the most active sector for B2B investing during the previous two years. PE firms invested in 122 industrial supplies and parts businesses in 212, but only executed 23 deals in the sector during the first half of 213. One area of strength in commercial products has been aerospace and defense; the sector saw 21 investments in H1 213, compared to 29 in all of 212. In addition, investors are once again exploring opportunities in building products, construction and similar areas that have been avoided following the housing bust. Capital invested details Median deal size ($M) PE transactions ($ amount) by sector $1 $9 $8 $7 $6 $5 $4 $3 $2 $1 $ * Buyout Growth *As of 6/3/213 1% 8% 6% 4% 2% % Other Transportation Commercial products *As of 6/3/213 Unlike deal flow, capital invested by B2B sector has changed significantly in recent years, as commercial services share of capital invested grew from 43 percent in 211 to 6 percent in H Benjamin Redman, director of transaction advisory services at McGladrey, says that despite recent slow deal flow, there remains optimism in the commercial services sector, as deal flow is expected to improve in the second half of the year, particularly in areas like logistics, advertising and media, maintenance and repairs management and waste management. The median deal size in B2B transactions has gone through cycles over the last decade, and it appears as if we are entering the trough of a downswing. Since hitting a decade high of $91.4 million in 21, the median buyout size has been cut by two-thirds (66 percent) to $31. million in H Marcotte has seen some PE firms assuming they will win a deal, but eventually falling short in a competitive bidding process. As dealsourcing continues to be difficult, this trend will likely drive up deal sizes in the coming quarters. [3]

5 Add-on deals in the B2B industry Add-on deals as a percentage of buyouts Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q % 6% 5% 4% 3% 2% 1% % Add-on Non add-on Add-on % of buyout PE firms are becoming increasingly focused on enhancing operations and expanding the bottom line for portfolio companies, and add-ons deals have become an integral component. Over the last several years, add-on deals have become more prevalent across all industries within PE, but the run-up has been especially pronounced in B2B in recent years. More and more PE firms are trying to execute addons as part of their normal value-enhancement business model, Marcotte says. Additionally, there were simply less opportunities for platform deals in the first half of the year because all of the good ones were sold last year. Add-on deals accounted for less than 5 percent of B2B buyouts throughout 21 and 211, before increasing in 212 and spiking to 6 percent in Q Another major contributor to the unprecedented level of addon activity in the first half of 213 is that these transactions are virtually always smaller and less complex than platform deals. As such, many of the companies that are attractive for add-on deals fly under the radar of most investors. This has allowed firms to execute deals with having to worry about some of the valuation and bidding concerns mentioned previously. Select B2B Q2 213 transactions Company name Investor Sector Amount ($M) Coinmach Service Pamplona Capital Management Commercial products $1,17 Emerald Expositions Onex Partners $95 EnergySolutions Energy Capital Partners $378 EDAC Technologies Greenbriar Equity Group Commercial products $11 Brand Networks AEA Investors $68 WorldOne Deerfield Management $35 [4]

6 Exit activity in the B2B industry B2B private equity exits (count) by exit type Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q Corporate acquisition IPO Secondary buyout Much as is the case on the dealmaking front, record-breaking exit activity in Q4 212 cannibalized many of the deals that would have closed in H1 213 under normal timelines. As such, PE firms have only realized 54 B2B exits so far in 213, which is barely half (53 percent) of the total from the same period last year. The recent slowdown may be short-lived, however. In the last six months, we ve done about the same amount of sell-side due diligence as we did in the prior 12 months, Marcotte says. It is important to keep in mind that PE firms operate in cycles, so periodic slowdowns should not be unexpected. If you re a PE firm, in light of the carried interest concerns and other issues, you were trying to exit at the end of last year, Marcotte says. PE firms are not exiting as much right now because they were in a sales mode last year, now they re in a buy mode and completing addons because that s where the activity is. Added Redman: Many B2B private equity exits (count) by exit type funds continued to raise capital in the first two quarters of 213, which also drove down exit activity. Secondary buyouts continue to be a popular exit strategy and are on track to outnumber corporate acquisitions for the third consecutive year. PE firms are using secondary buyouts as a dealsourcing strategy, which has resulted in more competition. This has both raised the prices for companies and prolonged the exit process. The majority of exits have been competitive auction processes related to secondary buyouts, Redman says. Strong stock market performance in recent quarters has compelled many investors to take their companies public. There have been eight IPOs in H1 213, including six in Q2. For comparison, there were only seven IPOs from PE-backed B2B companies in the previous six quarters. B2B private equity exits in Q2 213 by sector Commercial services 45% * Commercial products 45% Transportation 1% Corporate acquisition IPO Secondary buyout *As of 6/3/213 [5]

7 Top 12 accounting due diligence observations 1. Revenue recognition, especially related to target companies that derive the majority of revenue from large or lengthy projects, including project estimation, deferred revenue and customer deposits. Also, sales of bundled service packages that include multiple element arrangements. Important to differentiate whether these arrangements include software-as-a-service (common in certain consulting businesses recently, such as Salesforce.com or other CRMs), to determine if SOP 97-2 guidance is applicable, or alternatively, if they simply fall under a subscription revenue model and would fall under ASU Important to be able to determine if a value can be assigned to any of the individual services provided to clients or software. 2. Partner and owner compensation (historical vs. future and valuation or cash requirements of the business), including types of compensation such as salary vs. dividends. 3. W-2 vs. 199 employee function and reporting. 4. Employee utilization analysis and net realization by employee. 5. Employee turnover and ability to hire and retain qualified professionals. Treatment of severance and establishing normal business levels of severance payments when company operates a semi-variable staffing model. 6. Project backlog and waterfall analysis. 7. Customer and project profitability metrics: Are proper costs allocated? 8. Cash flow management: Pay employees and vendors prior to collection from customers, and large customer deposits received, which result in funding project upfront. 9. Gross to net analysis, especially related to target companies that provide large discounts on services rendered and staffing agencies that report on gross revenue basis, such as revenue = total hourly rate of contractors + commission, as opposed to solely commission revenue. Company s ability to properly estimate net collectible revenue and frequency of adjustments made to financial statements (monthly vs. annually). 1. Transportation: Fuel hedging, pass-through of fuel costs to customers and fuel profitability analysis. 11. Transportation: Capitalization of tire inventory. 12. Tax aspects and issues as they relate to partnership agreements and distributions applicable to each partner. The following list shows a detailed breakdown of the PitchBook industry codes for the B2B industry. 1. Business Products and Services (B2B) 1.1 Commercial products Transportation 1.4 Other business products and services [6]

8 Power comes from being understood. SM When you trust the advice you re getting, you know your next move is the right move. That s what you can expect from McGladrey. That s the power of being understood omissions, and not those of any other party. McGladrey, the McGladrey signature, The McGladrey Classic logo, The power of being understood, Power comes from being understood and Experience the power of being understood are trademarks of All Rights Reserved.