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2016 Mergers & Acquisitions Middle-Market Investor Outlook

Posted 5:00 AM by

How will the U.S.'s mergers and acquisitions middle market fare in 2016? That largely depends on past performances and trends, including global, economic and political factors, to see where the market has been.

As the moderator of the Stalwarts Roundtable at the 2015 M&A Advisor Summit, KSM explored this topic with several M&A luminaries. These panelists included: John K. Castle of Castle Harlan; Savio Tung of Investcorp; Jennifer St. Pierre of EMC; and Bob Morse of Strattam Capital.

Market-by-Market Performance

In reviewing year-to-year comparisons, more specifically the first three quarters of 2015, 1,439 deals closed compared to 1,528 for the same period in 2014. While that is a decrease of 89 deals for the year, it is not alarming since 2014 recorded the greatest number of deals since the recent recession.

When looking at conventional market breakouts, year-to-year performance is segmented as follows:

  • Lower Middle Market: Deal Size of $25-$100 Million. The market closed 443 deals in 2015 versus 534 deals in 2014. This is a 17% drop of 91 deals year-over-year. It turns out deal size was also a factor as the average deal size per quarter for 2015 ranged between $43 million to $29 million. In 2014, the average deal size per quarter was $46 million to $39 million – indicating a trend that deal sizes are decreasing at the lower middle market.
  • Core Middle Market: Deal Size of $100-$500 Million. This year-to-year comparison indicated a slight (20 deal) uptick: 774 in 2015 versus 754 in 2014, although the deal size was smaller – $150 million to $184 million in 2015, and $184 million to $197 million in 2014.
  • Upper Middle Market: Deal Size of $500 Million to $1 Billion. In this category, I reported the number of deals in the first three quarters of 2015 versus 2014 decreased by 17 deals – from 240 to 223. Deal sizes also shrank from $642 million to $564 million in 2014; and $553 million to $445 million in 2015.

Based on the numbers posted, panelists were asked whether they thought these decreases were indicative of trends they were seeing or not; and if not, what were they seeing.

Castle responded by minimizing the importance of the slight downturn. "You need a microscope to even identify these numbers as trends," he said. "Globally and in the U.S., these changes are unnoticeable. A few percent decrease is not obvious. 

“What may change the market is the disruptions of the August 2015 stock market. Funding is less available than before, and debt levels were probably too high in 2014. Given the collapse in late summer, the multiples of debt have become more restricted. And in oil services and production, those markets have shut down. There may have been some deals deferred and prices are somewhat lower."

Castle added that his team is reporting there is also a "diminution of companies offered in the market. On average," he said, "the companies offered now are not as good as those available 12 months ago."

Tung agreed. "These comparisons really aren't indicative of trends. Investment banks have done a good job, and the market is efficient." He did, however, identify two other trends:

  1. An increase in roll-up strategies. Sponsors are focused on roll-ups. "They are paying a higher price and doing add-ons and tuck-ins."
  2. Major private equity players are moving downstream. Any softening in the market causes major private equity companies to move into the middle market, he said, adding that the arena is getting a little crowded.

Investcorp "doesn't look at the macro trend. Rather it's on generating the API, finding good deals, existing and returning money to the LPs. You have to be proactive in finding deals and value enhancement. I like tech and cyber security, and I see Asia and China trying to catch up in these important product and service areas."

Morse of Strattam Capital also likes tech, particularly for private equity in the lower, middle market. "Tech," he said, "is a horizontal sector. It impacts everything. Eight-five percent of all corporate computing is now done on machines [people] own and the norms are changing for buying software, hardware and outsourcing.

"There are 10,000 companies in this space," he continued, "and they need money to write software, design systems and so on. We're looking at companies in the tech area and they have compelling economics. There is a role for the private equity community to play here." 

The Future Is Global

Investcorp's Tung said his company expects 2016 to be "very good for us in middle market private equity. However," he added, "we have to be careful because prices will be high and margins thin." He forecasts there will be good deal flow, and cyber security and tech will be good. He expects more focus on cross-border transactions – an arena in which middle market sponsors and PEs typically do not focus. Tung also projects that bank financing will tighten up, and the mantra will be "thoughtful capitalization."

Castle was more cautious. "I think 2016 may not be quite as good as 2015," he told the audience. "Pricing will be a bit lower and money a bit tighter, but I don't see this as a sea change – just not quite as good as last year."

He did agree with Tung that cross-border transactions are likely to increase. It makes good sense, he explained. If the U.S. market is softening and the U.S. dollar is strong, it makes sense to buy overseas and sell in the states (and vice versa). "We have a company in the U.S. market we were able to buy inexpensively and sell in Australia. Arbitrage is taking place – deals are moving to the place in the world with the best financing."

About Katz, Sapper & Miller
KSM is a nationally recognized consulting, tax, and audit firm. Through our deep experience across multiple disciplines and industries, we leverage emerging technologies, combined with our people’s differing perspectives, ingenuity, and creativity, to help our clients solve their most difficult challenges.

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