By Doug Rogers
If you listen to ACG New York members in recent months, you are struck by the overwhelming news of frothy valuations caused by readily available debt and too much money chasing too few quality deals. ACG New York reflects the phenomena putting a dome on M&A activity. Recent deals, some of which have been closed at 10x to 13x EBITDA, have left many investors on the sideline. Others, not eager to sit on the bench, have slogged down the field working their deals yard-by-yard only to lose the ball at the goal line to an insupportable bid. Meanwhile, some of the winning bidders have candidly admitted “the overriding need (i.e., pressure) to put their Fund’s capital to work” (implying that the high multiples paid are justified by their mandate/intent and pressure to meet their Partnership requirements).
Overall, the market dynamics for acquiring good companies at attractive multiples has become problematic.
In addition to the new debt and seemingly infinite private equity capital chasing a finite number of companies, there are other players, including family office investors and public companies, the latter enjoying cheap currency (high stock prices), large cash positions seeking to be invested and a thirst for companies with even a hint of positive synergies. Just as some PEGs are primarily driven by acquiring companies, even at high multiples, some public company CFOs and Treasurers are also compelled (if not pressured) to put their cash balances to work. Furthermore, given their cheap currency (high stock prices), accessible, cheap debt and sometimes aggressive assumptions about synergy value, many “strategic investors” can and do outbid PEGs
So now, ACG New York members – comprised of PEGs, investment bankers and service members – face this strong challenge from the marketplace, and some other members are “at the crossroads” about investing at all! What more can one do? Do we sit on the sidelines and ride out the wave of bad weather? How can we not only survive but capitalize on the current environment?
Here are some suggestions for and actions taken by the ACG New York deal community:
1. Remain Disciplined While Emphasizing Your Differences
Stay faithful to your markets but highlight your operational, acquisition program, and management differences to sellers. You may see fewer deals, but you will gain points for adding value to your sellers.
2. Find and Ferret Out Every “Proprietary Advantage”
First, use your operating partners and business development professionals efficiently and fully. Remember, all ACG New York members, bankers and service providers, are deal sources. Mine every deal professional by conveying a concise summary of your investment criteria. Give speeches, schedule networking parties and meet leaders and “deal-minded people” in each field! This “under the radar screen” referral network is larger than people think.
3. Focus on Your Existing Portfolio – Pursue “Add-on” Acquisitions
If “multiple expansions” is a limited strategy today, then you should pursue finding synergies through revenue growth or cost cutting. Getting “down and dirty” with your companies and making compelling cases to prospective sellers about industry roll-ups and becoming part of a bigger, more efficient organization can provide strong returns. Plus, given the smaller scale of the add-ons (vis-à-vis the platform company) and the immense potential of industry/business consolidation, buyers can win a deal with a lower bid than a stand-alone company with significant scale might require.
4. Consider Carve-Outs and Spin-Outs
If you have the time and resources, carve-outs and spin-outs of unrelated, non-core businesses are “hot.” Public companies are keen on unlocking shareholder value and maximizing resource efficiency and carve-outs and spin-outs are a popular method to achieve this. This strategy, while potentially highly rewarding, does have some minefields to consider, including (1) the time required to extract a business from a parent company, (2) the great resources (manpower) needed to identify and contact a significant group of sellers, (3) the management, systems and legal advice required to close and manage/operate the Spun-off Entity “post-closing” as a stand-alone entity, and other factors. However, given a Strategic’s desire to jettison these “non-core” carve-outs, the winning bids can sometimes be achieved at reasonable multiples.
5. Review and Re-Visit Your Investment Criteria and Acquisition Process
As witnessed by some of the best known large PEGs coming down-market recently, many are reviewing their size, industry, and other investment criteria in light of market conditions. Consider what you know best but be open to changes in your target selection. Similarly, some PEGs have attempted to “tighten up,” i.e., to shorten and intensely qualify their investment selection process. How committed is the seller to selling the business? How serious is the seller about the buyer’s bid and interest? Is price the sole consideration? How can I predict the outcomes better and more quickly?
6. Be Patient
Investors and deal professionals committed to this asset class know that it wasn’t meant to be easy! The competition is fierce and it seems that almost everyone has an army of financial engineers, leading operators and brilliant strategists. Furthermore, investment cycles, such as those extant now, come and go. Good companies will generally emerge at reasonable if not attractive multiples for those funds with a disciplined and level-headed process, industry excellence and operational experience, and a clear vision of the seller’s untapped potential.
As ACG New York members, we should add value not only by offering great service, but by taking a broader view of our corporate clients, their needs, and their potential for growth in the M&A process. Each of us should help sustain our coveted New York deal community each and every way can.
Douglas H. Rogers, Jr. is an Executive Director at CBIZ Valuation Group, LLC. and a member of the ACG New York Board of Directors.