Anyone who saw the movie “Marathon Man” vividly remembers Laurence Olivier torturing Dustin Hoffman while continuing to ask the question, “Is it safe?” Much as Sir Laurence’s character “Szell” kept repeating the question to Hoffman’s “Babe” character, we in the M&A industry today are constantly asked, “Is it safe?” in regards to making acquisitions or divestitures in the current market.
“Is it safe?” As it pertains to acquisitions today, the answer may lie within your own perspective. From a market standpoint, today’s market would seem to favor buyers and acquirers for several reasons:
VALUATIONS
Factors Making It Safe
- Valuations for privately-held businesses are lower today than 18 months ago, although they are higher than they were just six or 12 months ago
- We see purchase price multiples in 2010 down approximately 7% from 2008 and approximately 13% from their peak in 2006/2007
- It took six years from the last trough to peak (2001 to 2007) in valuations; we expect the same cycle for the current M&A market, which means valuations will increase over time, but will not peak for several years
Factors Making It Unsafe
- Valuations for publicly-traded businesses are also lower today than at the peak of the market in 2007/2008. For buyers using their stock as currency, acquisitions today could be costly if their stock is undervalued.
- As mentioned above, valuations for privately-held businesses are also down (relative to recent market peaks). For buyers using their own company as collateral for debt to make acquisitions, lower valuations means less capital available for leverage.
MARKET CONFIDENCE
Factors Making It Safe
- Confidence in the economy seems to be increasing, even if only modestly. Companies, in general, are experiencing year-over-year growth from the trough in 2009.
- Positive results and year-over-year growth lead to greater confidence in the market as well as greater ability to finance acquisitions with debt/leverage
- Most executives believe the worst is behind us
- With increased confidence, buyers/acquirers might be more inclined to invest their capital in acquisitions rather than hoarding it for future operations
Factors Making It Unsafe
- While most agree the worst has past, no one is certain when the good times will return
- Market uncertainty leads bankers/lenders to be much more conservative in their lending; with less leverage available, acquirers must use more equity to close deals, depressing ROI in the short term
LEVERAGE
Factors Making It Safe
- While lending conservatively, there are many lenders who are aggressively seeking to deploy capital in the marketplace (most commonly seen with local/regional banks)
- Overall cost of capital is lower now than ever before
- Rates charged by senior lenders are at historic lows
- Rates charged by mezzanine lenders are higher than in the “go-go” days, but not as high as they have been in the past
- Alternative lenders (finance companies, leasing companies) are deploying capital at historically low rates
Factors Making It Unsafe
- We have seen a return of much stiffer loan covenants, including an insistence upon personal guarantees by many lenders
- Although interest rates are low, so are Debt to EBITDA ratios:
- This critical ratio is approximately 30% to 50% lower than 30 months ago
- The good news is the ratio is approximately 10% to 20% higher than 12 months ago
- Asset valuations are very low, severely limiting the amount of leverage available for some transactions
Is It Safe? Optimistic acquirers (contrarians) believe now is a fantastic time to make acquisitions and cite numerous examples of fortunes made by those with the intestinal fortitude to seize opportunities in down economies. Naysayers and pessimists believe now is a terrible time to acquire because equity and debt is so tight.
Is It Safe? For business owners looking for an exit or recapitalization opportunity, deals are still getting done today, at valuations not too far off the peak of the market. Furthermore, with fewer sellers in the market, quality sellers are getting more “looks” than usual. However, businesses with depressed earnings and/or no growth may get hammered in the market.
What are we recommending to our clients? There are excellent opportunities for both acquirers and sellers in this market, but only for high quality, well run, profitable businesses.
posted by Jim Zipursky