KUHN CAPITAL Friday, October 20, 2017
Dispatches from the front

Things Are Getting Better All the Time
(12/15/2002)

To pass along a bit of holiday cheer, we have several reasons to be optimistic about the M&A business in 2003.

But before we tell you why, you should understand how we define "good news": first, we focus on mid-market M&A transactions for information companies – data, software, professional services vendors and heavily-branded product manufacturers, so our comments below may apply only to those sorts of companies.

Second, what we like are many and larger deals. However, in this market some sellers may find themselves entertaining a transaction for less than felicitous reasons – e.g., they’re forced to act due to financial duress, etc. So with these two caveats, here’s what we call positive signs:


Sign 1
At least for us, business has been picking up these last six months, not so much in transaction values but in number of transactions. Though deals are still taking longer-than-average to close, there are more of them in the works.


Sign 2
We read reports claiming that the larger LBO shops like KKR are reporting in general twice the level of activity now as last year at this time. Causes: maybe slightly relaxed credit availability, but probably mostly lower deal prices are bringing these investors into their magic 80/20 or 75/25 debt/equity ratio range.


Sign 3
We believe we’re seeing gradually changing buyer and seller attitudes. (But tell us what you think -- take our M&A Attitudes Survey.) Sellers seem to be increasingly convinced that they won’t see significant improvements in demand for the foreseeable future and are therefore assuming that there’s not much to be gained by holding out for a higher value. In a related observation, we’re hearing economists timidly forecast demand increases starting in 2004, but to our mind that’s just another way of saying they can’t see around the bend, so they figure things must be -- by then -- better.

We also believe buyers are growing more convinced that they’re seeing a bottoming in prices, so they’re increasingly motivated to act now to get in on the ground floor.

Sign 4
The US tech services industry is distributing itself across the world. Specifically, we are seeing very active and usually Indian-based buyers of a certain type of American tech services vendor, one who boasts a strong marketing/sales function and client base, and with a siginificant portion of its services capable of being offshored. While, again, this trend may not be "good news" from the perspective of American employment (it raises the question of what the US economy will offer the world outside of being a market for others' products and services), the trend is good for the M&A business.


Sign 5
We thought IBM's recent purchase of Rational was a wonderful demonstration of realpolitik deal-making, and for that reason strikes an optimistic note. From one perspective, IBM overpaid: at a price of $2.1 billion, software development platform vendor Rational sold for 6.5 times sales. But from another perspective, the deal was cheap, done for a per share price of $10.50 when Rational stock traded at $25 as recently as last January. Putting aside the arguments for a strategic premium in the combination (which are compelling in their own right), the parties successfully bridged an enormous valuation gap. Said another way, at a price of $2.1 billion IBM voted in the future, while Rational came to terms with the present.

That’s positive!

Ryan Kuhn


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