KUHN CAPITAL Tuesday, March 20, 2018
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Best M&A Crash Ever


Reading the upbeat bulletins of most mid-market M&A advisories, you’d think what’s happening with transactions now is merely inconvenient. You’ve come to the right place for the facts.

Recession Depression
In general, when M&A transaction values drop, so do the number of deals closed. Mid-market EBITDA multiples today are some of the lowest in memory, 3.5x - 4x versus 2007's 5x-6x. So deal closings are way down, perhaps 10% of the level seen same quarter, last year.

Prices are down for a couple of reasons. One reason that applies, no matter who the buyer, is the fact that we’re in a recession and most companies are seeing sales declines or at least missed growth targets. Skittish buyers regard acquiring such a company as akin to “catching a falling knife”. They need to see discounts off the usual multiples to compensate for the risk that things could get even worse.

Strategic Withdrawal
Other reasons for low pricing have to do with the behavior and circumstances of the two major buying types -- "strategics" or corporations, and private equity groups. Strategics have an extraordinary amount of cash on hand but the future is uncertain, so they’re hoarding it and mostly standing on the sidelines. Strategics aren't well-known for going against the flow anyway. In sum, there's little bidding from them to push up auction prices.

Leveraging Is So Yesterday
Private equity firms are also cash-heavy, coming off a big 2007 funding year. But since they can’t get their usual pound of leverage (which is typically far higher than what strategics feel comfortable with), the only way to generate acceptable ROE is to buy cheap. In fact, they’re motivated to be even cheaper by the fact that whatever they buy now, they’re likely to have to spend more time and money on down the road.

That’s because exiting via an IPO is pretty much history these days and exiting via M&A will only generate, for the foreseeable future, low valuations. So PE firms are caught in a vise: they want to buy, indeed have to buy to justify their limited partners’ investment, but buying now takes guts and a helluva sweet deal.

Where has the leverage gone? With banks trying to shrink their balance sheets to keep the regulators off their backs and embroiled in workouts, they’re generally loath to loan. When they do, they often want investors to match the value of their loan with equity. No more 25% equity/75% debt structures.

Who Would Sell into This?
Many sellers braving this market tend to be those who have to sell. Nobody wants to do that at what may be the bottom, but lots of smaller business people have no choice. They’re running low on cash and/or getting pressure from “fatigued” lenders.

Larger strategics are emerging as a rich source of spin-offs as they focus on efficiency, dumping “non-core” units. They feel they can’t be distracted by the complexity of managing smaller divisions, even if they’re going to take a haircut in the process and the divisions are profitable.

Pain for Many, Gain for Some
There is a bright spot shining through this stygian darkness: for buyers of targets that are burdened with high overhead and R&D -- businesses whose expenses can be “right-sized” in step with declining revenues -- it may be a once-in-a-lifetime opportunity. Look for the entrepreneurial buyers of corporate fattened calves to profit mightily from their willingness to put those businesses on a crash diet.

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