By John Hintze
Valuations to stay high as quality acquisitions get snatched up fast.
Corporates searching for acquisitions to bolster revenues and broaden their product offerings are likely to confront continued competition and sky-high valuations in 2017. However, they may have a bit more of an edge over private-equity firms competing for the same targets. This tight market is backed up by a recent Moody’s Investor Service survey.
PitchBook, a private financial market platform recently acquired by Morningstar, noted in a recent report that the median valuation to EBITDA multiple through the Q3 2016 was 11.2 times, up from 10.2 times in 2015 and the highest level in at least six years.
Prepping and integrating acquisitions was one of the biggest issues discussed at NeuGroup peer meetings last year. That’s because multinationals have been taking advantage of gobs of cash on their balance sheets, inflated stock prices and historically cheap debt to make acquisitions to expand their product offerings and customer bases. Often facing off against PE firms also benefiting from low rates as well as abundant funding from institutional investors looking for yield, corporates have seen the valuations of potential acquisitions skyrocket.
PitchBook anticipates that trend continuing into 2017, given corporates’ continuing dim prospects for organic growth, and private equity firms’ swollen funds that at some point will have to be put to use.
“With the median US M&A transaction trading above [11 times] EBITDA… many deals simply don’t pencil out,” PitchBook says in its “2017 Private-Equity Crystal Ball Report.” Valuation multiples have increased significantly across the board, including at middle market companies, which given their higher risk have traditionally carried lower valuations.
One factor favoring “strategic” corporate buyers, especially those with high stock prices, is that PE firms now have to contribute higher levels of costlier equity to support deals, over cheap debt. On the other hand, as PitchBook notes, “Diligence processes are becoming lengthier and more expensive, as firms must be certain they can justify the multiples they are paying.”
A complication for both corporate and private equity acquirers is that many if not most higher quality companies have already been snatched up. As a result, deal value and volume fell by about 20% in 2016 as of the third quarter, compared to the year before.
“Moving into 2017, we expect deal flow to be more or less flat with 2016 levels,” PitchBook says. “High transaction multiples and a lack of quality assets in the market will challenge deal makers when it comes to sourcing…” Consequently, private equity firms are increasingly looking overseas for acquisitions, providing corporates with heightened competition in foreign markets they may be seeking to expand into.
“Besides the US, respondents [to a recent PitchBook survey] report strategies targeting companies in Europe, Canada, Mexico, Central and South America, South Asia and East Asia,” PitchBook says. “Most of our survey respondents were fairly busy at the time of taking the survey in November and December of 2016, with 81% reporting that their firm was currently in the process of negotiating deals.”
Most PE investors foresee three US interest rate increases in 2017, PitchBook says. However, they anticipate that will have little impact on the PE market, since most acquisitions are leveraged, and a 75-basis-point increase in rates is relatively small compared to the overall rate on leveraged loans.
The survey suggests corporates will see increased competition in 2017 from PE firms in sectors including energy, financial services, healthcare services, and technology, while competition for acquisitions will likely decrease in media and biotech.
Meanwhile, according to a Moody’s survey, 75% of respondents expect deal activity to increase. And transactions may be bigger, with 64% of survey respondents expecting deal sizes to increase. Divestitures may also be a major focus in 2017: 73% of survey respondents say they plan to shed businesses next year; that’s up from 48% in Moody’s M&A Trends Report of mid-year 2016. A top priority for executives was having a solid integration plan ahead of an acquisition.
In the survey, it was noted that effective integration planning was considered “the number one factor in ensuring that deals work.” This has also been the case in the NeuGroup universe. In a spring NeuGroup Global Cash and Banking group meeting, members were encouraged to leverage knowledge from outside of treasury and beyond finance and create cross-functional groups that can quickly integrate or divest a business; track lessons learned from past implementations and build institutional knowledge. For example, develop resource tools such as a questionnaire, deal sheet and contact list and update them on a regular basis; ensure good knowledge-transfer occurs and key documentation from the acquired company is retained or archived properly and finally, when possible, retain key employees from acquired company (S/T & L/T) and meet with SMEs early on and often in person.