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What's Next for M&A?

12/12/07

We’ve been attending panel discussions and reading a lot of industry speculation about the immediate future of middle-market M&A. What every red-blooded intermediary wants to know, of course, is whether the number of deals and their transaction values will go up or down as we tip-toe through the credit crunch into 2008.

Here’s the gist of those discussions:

  • Surprisingly, a number of M&A shops report that business is currently stronger than before the sub-prime meltdown. They guess this is due to sellers concluding that taxes will rise under Democratic rule, and that a recession -- if it occurs -- will kill deal pricing. Demographics also support this trend: Baby-boomer owners may be thinking they don’t have the time to wait out another cycle. Finally, American sellers realize that the cheap dollar is attracting increasingly active foreign buyers, even for mid-market transactions. So call all the above observations the “Better get out now than later” mentality.
  • Yes, mid-market lending is about 50 basis points more expensive than six months ago, and the menagerie of exotic or risky loan flavors like “covenant-lite”, “accordion” and “staple” are becoming threatened species. Leverage as a multiple of EBITDA is also down about half a turn. But these more rigorous terms haven’t so far diminished deal “animal spirits”.
  • That said, lenders’ capacity or willingness to loan have been materially curtailed. The liquidity pool is a lot shallower.
  • As a result, everybody seems to agree that the big, highly-leveraged private equity transactions are attracting dramatically less lender support.
  • The PE pull-back is tamping down big deal prices, opening the door to more strategics who had been side-lined by their unwillingness to pay up by using scary levels of debt. (PE firms have less of a problem with big-time leverage since their jobs aren’t on the line.) Many strategics now also have fat cash war chests built up over the recent prosperous years.
  • In addition to the strategics, we believe the vacuum created by the retreat of giant PE-sponsored deals may also be partially filled by sovereign funds, those shadowy overseas reservoirs of America’s trade deficit.

Bottom line: for the moment, mid-market M&A is moving ahead smartly, but a recession could rain hard on that parade. Mega-deal volume and pricing is declining and will continue to do so for some time, with the slack partially taken up by strategics and overseas investor groups.
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