The Micro-Cap Mystery

Anecdotally, it's not the lenders who are holding up activity in the small deal space.

 The deal market isn't necessarily running on all cylinders, but for the first time in a long time, nobody is pointing fingers at the lenders, as debt has been available for acquirers in most corners of the market. The one exception, however, has been the micro-cap space, although observers cite that even this segment is finally starting to loosen up as well.

"When the liquidity dried up in the market, smaller companies had a harder time because they were deemed to be more risky," observes Dominic Petito, CEO of private investment firm Wisdom Capital Partners.

Indeed, the numbers seem to reflect a mass defection from the micro-cap space. In 2006 and 2007, for instance, the number of disclosed deals falling below $50 million in value exceeded 1,870 each year, with $29.24 billion worth of transactions in 2006 and $27.68 billion in 2007. A bottom was reached last year, when there were just 1,191 transactions completed, worth a combined $16.72 billion.

So far, 2011 has maintained a pace more in line with 2010, with 674 deals completed as of the first week of August, worth a combined $9.7 billion, according to the data from Thomson Reuters. But sources observe that at least the lenders are slowly gravitating back to the micro-cap space, while dealmakers are optimistic that their return will entice buyers to do the same.

"By staying away from the market for so long, banks started to realize they were losing opportunities, especially as these businesses started to grow," cites Petito.

Dealflow, recently, has seemed to pick up, although much of the activity has been dominated by strategic buyers. Verint Systems, for instance, acquired Vovici Corp. in a $56.5 million July deal that included an earnout. Pfizer, also in July, agreed to acquire the 89% of Icagen Inc. that it didn't already own through a tender offer valued at $6 a share in cash, or slightly more than $40 million. Private equity has been active, although their interest seems to be confined to add-on deals, as evidenced by the $30 million acquisition of Prospective Direct by Apollo Management's Affinion Group.

Part of the appeal of the small-cap and micro-cap space, at least on the part of lenders, is that the landscape isn't nearly as heated as the middle market. This has created an opportunity for new entrants, such as Tim Clifford's Abacus Finance -- a senior lender founded in June that is targeting PE-backed companies with Ebitda of at least $3 million.

Beyond Abacus, observers point to commercial finance companies such as NXT Capital Partners, Madison Capital Funding and Maranon Capital as being active in the micro-cap space. And others note that the re-emergence of the business development companies has also trickled down to those targeting the micro-cap segment.

"We are seeing a lot of activity involving deals with $50 million [enterprise value] and above," Abacus's Clifford tells Mergers & Acquisitions, adding that lenders will also dip as low as the $25 million enterprise value range, and specifies that companies with at least $5 million in Ebitda have been able to find as much as 3x leverage. The only area still having trouble, Clifford says, is "the 'micro' micro-cap space," which he defines as deals below $10 million in size.

Brad Gevurtz, the head of investment banking at DA Davidson & Co., says it's the companies -- not the lenders -- who are still in a "de-leveraging" mode given questions about the economy and all of the uncertainty that surrounds Washington. "The regional and community banks want to lend," he insists. "They have the capital, but the demand isn't there."

But some believe that it's just a matter of time before the lender enthusiasm translates into more dealflow.

"The fact that people are willing to finance is helping [the market}," Petito cites. Petito, it's worth noting, launched Wisdom just months ago to target growth companies valued between $5 million and $50 million. He was formerly a co-head of investment and corporate banking with BMO Capital Markets.

And now that the debt has returned to the market, it's only a matter of time that the deals will follow. As some deal pros are keen to point out, the US Economic Census Bureau counts more than 55,000 lower middle-market companies throughout the US. It equates to a fully stocked pond for those looking to put money to work.


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