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Mergers & Acquisitions: A Look at the Year Ahead

December 19, 2016


Measuring by the number of mergers and acquisitions, the U.S. middle market is the most active sector, but 2016 saw a decline in both the number and value of transactions while valuations and multiples continued to rise. How will the challenges and opportunities from the past year influence mergers and acquisitions (M&A) in 2017?

At The M&A Advisor’s Annual Summit in New York on Nov. 9, 2016, KSM had the honor of chairing a Stalwarts Roundtable discussion on this very topic – “2016 Trends and the Outlook for 2017.” The results of a recent survey conducted by Katz, Sapper & Miller in partnership with The M&A Advisor were presented during the session. The survey asked experienced M&A professionals – executives, consultants, advisors, lenders, attorneys, investment bankers and other service providers – about their experiences in 2016 and their predictions for 2017. The panel was comprised of four high-level M&A professionals who discussed the results and shared their insights and experiences. The panelists included:

  • Amy Margolis, principal of origination at The Riverside Company
  • Larry Reinharz, managing director at Woodbridge International
  • Seth Wilson, founder and managing partner at Headhaul Capital Partners
  • Caroline L. Young, partner at Hammond, Kennedy, Whitney & Company

M&A Market Trends

Through the first three quarters of 2016, the number of U.S. middle-market deals decreased by 16 percent, and their value declined by 9.7 percent, continuing a trend that began in 2014. Digging further, deals in the lower middle market decreased by 7 percent year-over-year while they saw a 17 percent increase in value.

The middle market also saw a rise in add-on transactions, where acquisitions are added on to existing companies; companies owned by private equity firms (PEs) had the highest percentage of add-on deals in the last decade at 64 percent. And while PE-backed exits decreased from the prior year, the most interesting trend was that 52 percent of exits through the first three quarters of the year were secondary buyouts to other PEs.

Given these market dynamics, our survey explored M&A professionals’ experiences in this environment and their outlook for the future.

Survey respondents were asked to identify the top three to five challenges they encountered in 2016. The top challenge (55.2 percent) noted on the survey was identifying companies that would be good cultural fits with existing business interests. At 52.4 percent was concern over a business owner’s willingness to relinquish control. An acquisition target’s requirements of the buyer for integration and/or operational support was chosen by over 40 percent. Young noted that challenges for PE firms could be opportunities. For example, finding good cultural fits has been a strong area for her firm. “Our ability to really connect with those particular founders who are considering a sale, given our partnership mentality, has really been an opportunity for us,” she said. “On the sell side, I think sometimes if you get some of these PE groups that aren’t as good at connecting, that can be a challenge getting our management teams comfortable with these buyers coming in.”

When asked to rank the significance of opportunities that were primary influencers of buyers’ decisions in the past year, survey participants listed building a company for increased revenues and profits, investing in high-growth sectors, higher returns on investment (ROI), and creating a platform business that would command higher sales multiples. Panelists discussed that add-ons were key to building revenues and profits. “This year we’ve closed 30 transactions on the buy side,” said Margolis. “Roughly 80 percent of those have been add-ons. Many have been entrepreneurial companies that have been bolted on to our existing portfolio companies.”

The Year Ahead

Looking forward to 2017, just over half of the survey respondents said the trend they were encountering most frequently in middle-market M&A was increasing business valuation, reflecting higher EBITDA multiples; additionally, over 40 percent said they were noticing an increasing volume of industry consolidations. Margolis reaffirmed the survey results, citing an example from her firm’s micro-cap fund, which features investment companies under $7 million in EBITDA: “In that fund, in particular, we’ve seen very lofty valuation expectations on the part of sellers.” Reinharz agreed and noted that higher valuations bring additional challenges when working with sellers. “Ninety percent of my time is educating people on being realistic,” he said. Confirming the prevalence of consolidation, Wilson said, “We are seeing a tremendous amount of it in the transportation sector.” He attributed the increased number of consolidations to generational change combined with increased government regulations.

Panelists and surveyed M&A professionals were in agreement that technology, healthcare and financial services were the three hottest sectors for 2017. “We’re doing a lot in the software as a service (SaaS) platform – tremendous growth opportunities there,” said Margolis. “I was a little surprised to see energy as fourth,” Young said. “But I do think that will come back.”

The consensus among survey participants was that political factors and interest rate fluctuations would have the greatest influence on U.S. M&A growth in 2017. Given that some in the M&A industry are saying that 2017 is going to be steady and that issues will start in 2018, the panelists were asked to give their predictions for how money would be deployed over the next two years. Panelists said that investment bankers they work with have seen declines in deal flow but have steady pipelines as 2017 approaches. Wilson added, “I think, with uncertainty over the next two to three years, people will be a little more hesitant to transact,” citing stability as a fertile ground for M&A activity.

When asked about their key advantages for staying ahead of the competition, panelists cited sourcing, building the funnel and global reach. “We’re spending more and more money on more marketing,” Reinharz said. “The more business owners we speak with, the better engagements we’re going to have.”

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