Big-ticket deals made a lot of headlines late last year, but the middle market remained quiet as midsize firms stayed on the sidelines, looking for credit, shoring up their own businesses, and waiting for a sign that the economic storm had passed. Now, a host of factors are combining to create a fertile environment for mergers and acquisitions valued in the $100 million to $1 billion range.
The most important factor is that deals can be financed again. “Financing had been the key missing ingredient, and now it’s available,” says Howard Lanser, director of mergers & acquisitions at Robert W. Baird, an asset-management firm. “If you are a stable business and can prove that you are through the bottom of the cycle, you can find creditors looking to put capital to work.” The robust recoveries in the equity and high-yield-debt markets have also provided more capital-raising options for middle-market buyers, in addition to boosting the confidence so critical to deal making, adds Lanser.
That return to confidence, however fragile, comes as many finance chiefs have steadied their businesses, built up significant cash cushions, and started to cast about for growth options. Mergers and acquisitions look especially appealing given the sluggish state of the economy, which seems unlikely to provide many opportunities for rapid organic growth anytime soon.
“The mood shifted dramatically after Labor Day last year,” says Lanser. “In the fourth quarter, companies went from ‘M&A would be nice if we could do it but we’ve got a lot of other things going on right now’ to ‘M&A is at the top of our agenda.’” In a recent report titled “M&A Market Analysis 2010: Hope Springs Eternal,” Baird analysts noted that December 2009 featured an uptick in middle-market activity, with a 14% increase in the number of announced deals versus December 2008 and a 54% increase in the dollar value of those deals.
Among those entering the fray in the middle market starting last fall were Danaher, which acquired Applied Biosystems for $450 million; Thermo Fisher Scientific, which bought BRAHMS AG for $471 million; Monsanto, which acquired Chesterfield Village Research Center from Pfizer for $435 million; and Teva Pharmaceuticals, which picked up OncoGenex Pharmaceuticals for $430 million.
Another key change has been the stabilization of valuations, an important factor for buyers and sellers alike. Late last year, “valuations started ticking up from the low of the first quarter of 2009,” says Lanser. “Buyers could see that a bottom had been hit and that now was the time to do something, and sellers could see that they were off the bottom, too.” As a result, expectations on both sides of the deal have edged closer to a mutually agreeable meeting point, something that proved elusive for much of 2009 as sellers hesitated to drop prices to the recession-era levels that buyers were demanding. Enterprise value-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) multiples fell from an average of 9.5 times in 2008 to 7.5 times in 2009, a drop that required a major adjustment of sellers’ hopes.
Still, the road to successful transactions is far from smooth. Advisers continue to warn finance chiefs to brace for extremely intense due-diligence scrutiny of any deal, by both buyers and creditors. “Diligence is invasive,” says Lanser. “Whereas before it was an outpatient procedure, now it’s major surgery.” For those who are looking to sell all or part of a business, the ability to show continued strong performance, or a strong recovery from a weak 2009, is critical. “Make sure you can demonstrate in detail that if you were at the bottom, you’re off it now,” says Lanser.
In general, there is a sense that the M&A market is headed in the right direction, along with the broader economy. But many remain unsure whether the timing for a deal is quite right. Says Lanser, “People are trying to figure out whether this is a deal-making window that is going to close, or whether it’s a door that’s really open.”