Dying Companies Keeping M&A Alive

Dealmakers predict an uptick in activity buoyed by the purchases of distressed companies during the latter half of 2009.
Sarah JohnsonMay 13, 2009

Their signature pens may not have been very active lately. But dealmakers themselves are keeping busy with a focus on distressed companies, either scouring the growing bargain bin of financially hurting companies or nursing the ones in their investment portfolios.

Indeed, deal mavens are counting on buys of distressed companies to keep the M&A world buzzing in an industry that has been quiet in recent months. So they say in a new report released today by the Association of Corporate Growth and Thomson Reuters.

Nearly all of the 703 respondents — including middle-market private-equity pros, venture capitalists, investment bankers, lenders, and entrepreneurs — characterized the current M&A environment as fair or poor. But they’re taking an optimistic view of the future: A little over half believe activity will increase over the next six months.

If their predictions are true, then many of the deals will involve companies struggling to make ends meet. More than half of the private-equity respondents are seeking distressed companies now, and 61% of all the dealmakers surveyed predict that distressed sales will make up at least one-quarter of all M&A deals over the next six months. Moreover, 19% of the respondents say they have recently changed their investment strategies to focus on troubled firms. (Still, 45% of the dealmakers said distressed companies will never be part of their investment plans.)

ACG, which conducted the survey last month, said the results reflect its members’ most negative outlook since the association began doing the twice-yearly survey five years ago. Midmarket M&A deals announced in the first quarter of 2009 fell 48% compared to the same period as 2008. Those deals — defined by Thomson Reuters as transactions under $500 million — totaled $98.3 billion in the first quarter of 2009.

In terms of industries, respondents predict that most M&A activity for the rest of 2009 will come from deals involving health-care/life sciences companies (24%), manufacturers (22%), and financial services firms (17%).

To be sure, there’s plenty of willing sellers for potential buyers to consider. Last month, corporate venture capitalists lamented that most of the companies on the market were in a distressed state, desperate for financing. Trouble is, of course, there’s not much financing to go around. For example, 90% of PE professionals in ACG’s survey said they’re affected by the lack of acquisition financing.

Brent Brown, managing partner for Madison Parker Capital, estimated at the National Venture Capital Association’s annual meeting that 80 percent of companies looking for venture backing are in distress, have balance-sheet issues, or are in a workout situation. Only companies that can offer double-digit revenue growth, increases in earnings before interest, depreciation,taxation, and amortization (EBIDTA), and good management are getting “decent” valuations, he added.

Still, some sellers are good companies that have simply “hit a rough patch” and have few options for getting on their feet beyond selling in a distressed state or liquidating, says Dennis White, ACG vice chairman and partner at McDermott, Will & Emery LLP.

So what’s holding up deals? Besides the buyers’ ability to get financing, it’s the price. “Clearly, sellers would like to say, Gee, the last six months were an aberration, we were a much stronger company a year or two ago,” White tells CFO.com. “The buyers, on the other hand, are reluctant to buy, saying, ‘We have to value you as we find you today and at a lower price.’” The result, White adds, is a “disconnect” between buyers and sellers.

In the meantime, PE professionals are spending more time working with their portfolio companies after more than half of them had to write down the value of these investments last quarter. They are working with company management on strategy (78%), renegotiating loan terms and commitments (45%), and renegotiating contracts with suppliers (17%), according to the ACG study.