The past five months have seen an abysmal merger and acquisition market, as can be expected. Merger and acquisition activity is often considered a lagging indicator of the economy, and will likely continue to underperform for the next two quarters. However, the rising consumer confidence index paired with low retail inventory levels could create a solid upswing in factory orders, a strong indicator that the economy could be improving. This could positively impact M&A activity, as buyers will gain confidence after seeing a floor to their acquisition targets’ revenue levels. M&A will not be considered healthy until banks’ confidence in the economy improves and they are willing to take on additional risk. With the economy improving, banks will likely loosen their credit standards, which should gear up the M&A market in the third quarter this year. While the beginning of renewed interest from buyers of companies is just starting to become evident, we don’t expect to see improvements in M&A statistics until the first quarter of 2010. However, behind the scenes, valuations will start to stabilize and return to historical norms in the fourth quarter of 2009. M&A Activity will continue to Slow As the economy worsened in the fourth quarter of 2008, many buyers and sellers were cancelling or postponing transactions in the first quarter. Deals that were being completed were those that were already in the pipeline before the slow down or were distressed deals of necessity. Because transactions in this tight lending environment will take longer to get done, we can expect M&A activity in the second and third quarter of 2009 to get worse before it gets better.  Valuations While there are fewer deals getting done, lower-middle market valuations (TEV of $10MM and $250MM) have been stable. Average valuations have been steady at 5.9X EBITDA compared to 6.2X in the first half of 2007 and 5.7X in (full year or the first half of ) 2003. We do expect slightly lower valuations for the second and third quarter as more distressed deals and deals of necessity are completed. However, Wyatt Matas & Associates has demonstrated in other reports that valuations for lower-middle market companies are not especially volatile regardless of economic conditions. While average valuations are expected to be slightly lower in the short-term, they should stabilize to the norm later in the year.
While the lending environment has provided new challenges for companies to find operating capital, it has been next to impossible for financial buyers to find debt in order to complete acquisitions. Private equity buyers have had to contribute more of their own capital to complete deals. This continues a trend that started in the first half of 2007, where the percentage of equity contribution was 41.0% compared to 59.2% in the first quarter of 2009. Higher equity contributions to a deal from private equity buyers typically means that they will put pressure to complete deals at lower valuations to protect their return on equity. The Merchant Wholesalers’ Inventories report indicates that March and April’s inventory drawdown were the largest in history. While sales continued to decline at a faster pace than inventories were drawn down, making this a net-net negative report, if consumers start to spend later in the year, as the sentiment report suggests, merchants will have to began restocking there inventories soon. Expect this report to improve in May and June. These two reports are validated by the May ISM New Order report, which moved above 50 for the first time in 6 months. (Above 50 indicates growth.) The ISM New Order report is a key leading indicator of industrial production. The report is derived from interviewing purchasing managers for industrial companies, and suggests that they have started to see new orders coming in as merchants increase their inventories to meet future demand. We should start to see evidence of this in the May and June Wholesalers Inventory reports. |
